L1 - Introduction to Economics of the Financial System Flashcards Preview

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Flashcards in L1 - Introduction to Economics of the Financial System Deck (71)
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1
Q

How is the term Financial System defined?

A
  • A process that facilitates an exchange of funds
  • financial system is a set of institutions, such as banks, insurance companies, and stock exchanges, that permit the exchange of funds. Financial systems exist on firm, regional, and global levels. Borrowers, lenders, and investors exchange current funds to finance projects, either for consumption or productive investments, and to pursue a return on their financial assets. The financial system also includes sets of rules and practices that borrowers and lenders use to decide which projects get financed, who finances projects, and terms of financial deals.
  • These systems can differ from country to country
2
Q

What is an important issue around regulations in the Financial System?

A
  • Investors are always looking for a way around them
  • That’s why they always need adapting, refining and modifying as time goes on
3
Q

Who are the Participants in the Financial System?

A
  • Depository Institutions (banks)
  • Contractual Savings Institutions
  • Investment Intermediaries
  • Merchant Banks
  • Companies/Firms
  • The Individual
  • Government
  • The Central Bank
  • Regulators
4
Q

What is the role of Depository Institutions in the Financial System?

A
  • Depository institutions (for simplicity, we refer to these as banks throughout this text) are financial intermediaries that accept deposits from individuals and institutions and make loans.
  • These institutions include commercial banks and the so-called thrift institutions (thrifts) : savings and loan associations, mutual savings banks, and credit unions.
5
Q

What is the role of Commercial Banks in the Financial System?

A
  • These financial intermediaries raise funds primarily by issuing checkable deposits (deposits on which checks can be written), savings deposits (deposits that are payable on demand but do not allow their owner to write checks), and time deposits (deposits with fixed terms to maturity).
  • They then use these funds to make commercial, consumer, and mortgage loans and to buy U.S. government securities and municipal bonds. Around 5,000 commercial banks are found in the United States, and as a group, they are the largest financial intermediary and have the most diversified portfolios (collections) of assets.
6
Q

What is the role of Saving and Loan Associations and Mutual Savings Banks in the Financial System?

A

These depository institutions, of which there are approximately 900, obtain funds primarily through savings deposits (often called shares ) and time and checkable deposits. In the past, these institutions were constrained in their activities and mostly made mortgage loans for residential housing.

Over time, these restrictions have been loosened so the distinction between these depository institutions and commercial banks has blurred. These intermediaries have become more alike and are now more competitive with each other.

7
Q

What is the role of Credit Unions in the Financial System?

A

These financial institutions, numbering about 7,000, are typically very small cooperative lending institutions organized around a particular group: union members, employees of a particular firm, and so forth. They acquire funds from deposits called shares and primarily make consumer loans.

8
Q

What is the role of Contractual Saving Institutions in the Financial System?

A

Contractual savings institutions, such as insurance companies and pension funds, are financial intermediaries that acquire funds at periodic intervals on a contractual basis.

Because they can predict with reasonable accuracy how much they will have to pay out in benefits in the coming years, they do not have to worry as much as

As a result, the liquidity of assets is not as important a consideration for them as it is for depository institutions, and they tend to invest their funds primarily in long-term securities such as corporate bonds, stocks, and mortgages.

9
Q

What is the role of Life Insurance Companies in the Financial System?

A

Life insurance companies insure people against financial hazards following a death and sell annuities (annual income payments upon retirement).

They acquire funds from the premiums that people pay to keep their policies in force and use them mainly to buy corporate bonds and mortgages.

They also purchase stocks but are restricted in the amount that they can hold. Currently, with $6.4 trillion in assets, they are among the largest of the contractual savings institution

10
Q

What is the role of Fire and Casualty Insurance Companies in the Financial System?

A

These companies insure their policyholders against loss from theft, fire, and accidents. They are very much like life insurance companies, receiving funds through premiums for their policies, but they have a greater possibility of loss of funds if major disasters occur.

For this reason, they use their funds to buy more liquid assets than life insurance companies do. Their largest holding of assets consists of municipal bonds; they also hold corporate bonds and stocks and U.S. government securities.

11
Q

What is the role of Pension Funds and Government Retirement Funds in the Financial System?

A

Private pension funds and state and local retirement funds provide retirement income in the form of annuities to employees who are covered by a pension plan.

Funds are acquired by contributions from employers and from employees, who either have a contribution automatically deducted from their pay checks or contribute voluntarily. The largest asset holdings of pension funds are corporate bonds and stocks.

The establishment of pension funds has been actively encouraged by the federal government, both through legislation requiring pension plans and through tax incentives to encourage contributions.

12
Q

What are the different sections under-investment intermediaries?

A

This category of financial intermediaries includes finance companies, mutual funds, money market mutual funds, and investment banks.

13
Q

What is the role of Finance Companies in the Financial System?

A

Finance companies raise funds by selling commercial paper (a short-term debt instrument) and by issuing stocks and bonds. They lend these funds to consumers (who make purchases of such items as furniture, automobiles, and home improvements) and to small businesses.

Some finance companies are organized by a parent corporation to help sell its product. For example, Ford Motor Credit Company makes loans to consumers who purchase Ford automobiles.

14
Q

What is the role of Mutual Funds in the Financial System?

A

These financial intermediaries acquire funds by selling shares to many individuals and use the proceeds to purchase diversified portfolios of stocks and bonds.

Mutual funds allow shareholders to pool their resources so that they can take advantage of lower transaction costs when buying large blocks of stocks or bonds.

In addition, mutual funds allow shareholders to hold more diversified portfolios than they otherwise would.

Shareholders can sell (redeem) shares at any time, but the value of these shares will be determined by the value of the mutual fund’s holdings of securities. Because these fluctuate greatly, the value of mutual fund shares does, too; therefore, investments in mutual funds can be risky.

15
Q

What is the role of Money Market Mutual Funds in the Financial System?

A

These financial institutions have the characteristics of a mutual fund but also function to some extent as a depository institution because they offer deposit-type accounts. Like most mutual funds, they sell shares to acquire funds that are then used to buy money market instruments that are both safe and very liquid.

The interest on these assets is paid out to the shareholders. A key feature of these funds is that shareholders can write checks against the value of their shareholdings. In effect, shares in a money market mutual fund function like checking account deposits that pay interest.

Money market mutual funds have experienced extraordinary growth since 1971, when they first appeared. By the end of 2015, their assets had climbed to nearly $2.7 trillion.

16
Q

What is the role of Hedge Funds in the Financial System?

A

Hedge funds are a type of mutual fund with special characteristics. Hedge funds are organized as limited partnerships with minimum investments ranging from $100,000 to, more typically, $1 million or more.

These limitations mean that hedge funds are subject to much weaker regulation than other mutual funds. Hedge funds invest in many types of assets, with some specializing in stocks, others in bonds, others in foreign currencies, and still others in far more exotic assets.

17
Q

What is the role of Investment Banks in the Financial System?

A

Investment Banks Despite its name, an investment bank is not a bank or a financial intermediary in the ordinary sense; that is, it does not take in deposits and then lend them out. Instead, an investment bank is a different type of intermediary that helps a corporation issue securities.

First it advises the corporation on which type of securities to issue (stocks or bonds); then it helps sell (underwrite) the securities by purchasing them from the corporation at a predetermined price and reselling them in the market.

Investment banks also act as deal makers and earn enormous fees by helping corporations acquire other companies through mergers or acquisitions.

18
Q

What is the role of Merchant Banks in the Financial System?

A

A merchant bank is a company that conducts underwriting, loan services, financial advising, and fundraising services for large corporations and high net worth individuals.

Unlike retail or commercial banks, merchant banks do not provide services to the general public. They do not provide regular banking services like checking accounts and do not take deposits.

These banks are experts in international trade, which makes them specialists in dealing with multinational corporations. Some of the largest merchant banks in the world include J.P. Morgan, Goldman Sachs, and Citigroup.

19
Q

What is the role of Companies/Firms in the Financial System?

A
  • Raise money on the various stock markets in exchange for a percentage ownership of their company
  • Investment intermediaries buy these instruments in hopes of their price rising in order to make money for their clients.
  • Also directly supply funds to be lent out to other business.
20
Q

What is the role of the individual in the Financial System?

A
  • Supplying money to banks through bank deposits
  • Use of pension funds and mutual funds
  • Retail traders are involved directly in the financial market usually trading derivatives and risk.
  • Borrowing money for mortgages or business loans
21
Q

What is the role of Government in the Financial System?

A
  • Regulations e.g. Volker Rule
  • Fiscal and Monetary policy
  • Auction of Government Bonds
  • Bailout
  • Raising Finance
22
Q

What is the role of Regulators in the Financial System?

A
  • Federal and state governments have a myriad of agencies in place that regulate and oversee financial markets and companies.
  • These agencies each have a specific range of duties and responsibilities that enable them to act independently of each other while they work to accomplish similar objectives.
  • Although opinions vary on the efficiency, effectiveness and even the need for some of these agencies, they were each designed with specific goals and will most likely be around for some time.
  • With that in mind, the following article is a complete review of each regulatory body.
23
Q

What is the role of the Central bank in the Financial System?

A
  • The central bank has been described as “the lender of last resort,” which means it is responsible for providing its nation’s economy with funds when commercial banks cannot cover a supply shortage.
  • In other words, the central bank prevents the country’s banking system from failing. However, the primary goal of central banks is to provide their countries’ currencies with price stability by controlling inflation.
  • A central bank also acts as the regulatory authority of a country’s monetary policy and is the sole provider and printer of notes and coins in circulation.
  • Time has proved that the central bank can best function in these capacities by remaining independent from government fiscal policy and therefore uninfluenced by the political concerns of any regime.
  • A central bank should also be completely divested of any commercial banking interests.
24
Q

What is the Money Market?

A

Said to be unorganised

The Money market refers to the market where borrowers and lenders exchange short term funds to solve their liquidity needs. Money market instruments are generally financial claims that have low default risk, maturities under one year and high marketability

25
Q

What is the Capital Market?

A
  • Much more organised than the money market
  • The Capital market is a market for financial investments that are direct or indirect claims to capital. It is wider than the Securities Market and embraces all forms of lending and borrowing, whether or not evidenced by the creation of a negotiable financial instrument.
  • The Capital Market comprises the complex of institutions and mechanisms through which intermediate term funds and long-term funds are pooled and made available to business, government and individuals.
  • The Capital Market also encompasses the process by which securities already outstanding are transferred.
    • Primary market: A primary market where the fresh issue of securities are offered to the public
    • Secondary market: A secondary market where issued securities are traded between the investors.
26
Q

What is an Organised Market?

A

Organized market is that part of the financial markets, which operates under a defined set of rules, regulations and legal provisions and the statutory authorities such as the Central Government, the Central Bank the Exchange Commission (such as SEBI in India), etc. The organized market may also be called the official or formal market.

27
Q

What is an Unorganised market?

A
  • Unorganized is that part of the financial markets, which is not standardized and is outside the preview of government control. In India, the rural money lenders and traders form the unorganized market.
  • The basic feature of unorganized market are high interest rates, fluctuating and varying interest rates, absence of precise rules, upfront payment of interest, unsystematic arrangements etc.
28
Q

What is a Dealer?

A
  • Dealers are people or firms who buy and sell securities for their own account, whether through a broker or otherwise.
  • A dealer acts as a principal in trading for its own account, as opposed to a broker who acts as an agent who executes orders on behalf of its clients.
  • Dealers are important figures in the market. They make markets in securities, underwrite securities, and provide investment services to investors.
  • That means dealers are the market makers who provide the bid and ask quotes you see when you look up the price of a security in the over-the-counter market. They also help create liquidity in the markets and boost long-term growth.
29
Q

What is a Clerk?

A

A financial clerk is someone who governs many different financial transactions in businesses by keeping track of a company’s money. These individuals primarily perform administrative work for banking, insurance, and other companies. They keep records, help customers, and carry out financial transactions.

30
Q

What is meant by the term ‘bid’ and ‘offer’?

A

The bid price is what the market maker will pay you to sell your shares to them (it’s what they’ll bid for it).

The offer price is what you have to pay to buy shares from them. The offer price is usually higher than the bid price so that the market maker can make a profit

31
Q

What is meant by the term ‘spread’?

A

The bid-offer spread is simply the difference between the price at which you can buy a share and the price at which you can sell it. There is a difference between the two prices because this is how the people who ensure there is a market for the shares (known as ‘market makers’) make money.

32
Q

What is an instrument?

A
  • Financial instruments are assets that can be traded, or they can also be seen as packages of capital that may be traded. Most types of financial instruments provide efficient flow and transfer of capital all throughout the world’s investors.
  • These assets can be cash, a contractual right to deliver or receive cash or another type of financial instrument, or evidence of one’s ownership of an entity
  • A financial instrument is a monetary contract between parties. We can create, trade, or modify them. We can also settle them.
  • A financial instrument may be evidence of ownership of part of something, as in stocks and shares. Bonds, which are contractual rights to receive cash, are financial instruments.
33
Q

What are some different types of Instruments?

A

Types of Financial Instruments:

  • Cash Instruments
  • Derivative Instruments

Types of Assets Classes of Financial Instruments:

  • Debt-Based Financial Instruments
  • Equity-Based Financial Instruments
34
Q

What are Cash Instruments?

A

The values of cash instruments are directly influenced and determined by the markets. These can be securities that are easily transferable.

Cash instruments may also be deposits and loans agreed upon by borrowers and lenders.

35
Q

What are Derivative Instruments?

A

The value and characteristics of derivative instruments are based on the vehicle’s underlying components, such as assets, interest rates, or indices.

These can be over-the-counter (OTC) derivatives or exchange-traded derivatives.

36
Q

What are Debt-Based Financial Instruments?

A
  • Short-term debt-based financial instruments last for one year or less. Securities of this kind come in the form of T-bills and commercial paper. Cash of this kind can be deposits and certificates of deposit (CDs).
  • Exchange-traded derivatives under short-term, debt-based financial instruments can be short-term interest rate futures. OTC derivatives are forward rate agreements.
  • Long-term debt-based financial instruments last for more than a year. Under securities, these are bonds. Cash equivalents are loans. Exchange-traded derivatives are bond futures and options on bond futures.
  • OTC derivatives are interest rate swaps, interest rate caps and floors, interest rate options, and exotic derivatives.
37
Q

What are Equity-Based Financial Instruments?

A

Securities under equity-based financial instruments are stocks. Exchange-traded derivatives in this category include stock options and equity futures. The OTC derivatives are stock options and exotic derivatives.

38
Q

What is an Equity?

A
  • Equity is typically referred to as shareholder equity (also known as shareholders’ equity) which represents the amount of money that would be returned to a company’s shareholders if all of the assets were liquidated and all of the company’s debt was paid off.
  • Equity is found on a company’s balance sheet and is one of the most common financial metrics employed by analysts to assess the financial health of a company.
  • Shareholder equity can also represent the book value of a company. Equity can sometimes be offered as payment-in-kind.
    • There are various types of equity that extend beyond a corporation’s balance sheet. In this article, we’ll explore the different types of equity including how investors can calculate a corporation’s equity or net worth.
39
Q

What is Equity financing?

A
  • Equity financing is the process of raising capital through the sale of shares. Companies raise money because they might have a short-term need to pay bills or they might have a long-term goal and require funds to invest in their growth. By selling shares, they sell ownership in their company in return for cash, like stock financing.
  • Equity financing comes from many sources; for example, an entrepreneur’s friends and family, investors, or an initial public offering (IPO). Industry giants such as Google and Facebook raised billions in capital through IPOs.
  • While the term equity financing refers to the financing of public companies listed on an exchange, the term also applies to private company financing.
40
Q

What is a year in the money market?

A
  • Its instrument specific e.g. in the US some instruments has a maturity date of 360 days while in London they have a maturity of 365 days
  • we use the term a year
41
Q

What is a paper market?

A

A market for contracts where delivery is settled in cash, rather than by delivery of the physical product on which the contract is based.

42
Q

What is the inter-bank market?

A

The interbank market is the global network utilized by financial institutions to trade currencies between themselves.

While some interbank trading is done by banks on behalf of large customers, most interbank trading is proprietary, meaning that it takes place on behalf of the banks’ own accounts. Banks use the interbank market to manage exchange rate and interest rate risk.

43
Q

What is the function of the Bank of England?

A

The Bank of England’s primary functions are to maintain monetary stability and oversee financial stability of the UK financial system. The bank also acts as the lender of last resort and also as the custodian to the official gold reserves in the United Kingdom.

  • set the interest rate which most banks generally follow.

-

44
Q

What is the function of the Bank of England in the interbank market?

A
  • lender of last resort –> try to go to other banks first
    • but will change the terms at which they lend you money
    • what is meant by term in this sense
    • if shortage comes about because of the bank, the BOE will change the dealing rates
    • IF shortage comes about because of the market they will lend funds at the going rate
    • if BoE changes spreads and dealing rates - it affects all other banks
45
Q

What are the different time frames in the money market?

A
  • maturity, not duration
  • the longer into the future the better the rates
46
Q

What is the difference between maturity and duration in the money market?

A

Plain and simple, duration is the measure of a bond’s sensitivity to changes in interest rates

Maturity is pretty straightforward. A bond’s maturity is the length of time until the principal must be paid back

47
Q

What is LIBID?

A
  • The acronym LIBID stands for London Interbank Bid Rate. It is the bid rate that banks are willing to pay for eurocurrency deposits and other banks’ unsecured funds in the London interbank market. Eurocurrency deposits refer to money in the form of bank deposits of a currency outside that currency’s issuing country. They may be of any currency in any country.
  • The most common currency deposited as eurocurrency is the U.S. dollar. For example, if U.S. dollars are deposited in any bank outside the United States—Europe, the United Kingdom, anywhere—then the deposit is referred to as a eurocurrency.
48
Q

What is LIBOR?

A
  • LIBOR (officially ICE LIBOR) stands for London Interbank Offered Rate. LIBOR is the interest rate at which banks can borrow money (unsecured funds) from other banks in the London interbank market for a specified period of time in a specified currency.
  • The benchmark rate is calculated for seven maturities for five currencies: the Swiss franc, the euro, the pound sterling, the U.S. dollar, and the Japanese yen. There are actually 35 rates that are released to the market every day.
49
Q

What is the key differences between LIBID and LIBOR?

A

LIBOR and LIBID are both calculated and published daily. However, unlike LIBID, which has no formal correspondent responsible for fixing it, LIBOR is set and published daily around 6:45 a.m. EST (11:45 a.m. in London) by the ICE Benchmark Administration (IBA).

Both these rates (especially LIBOR) are considered the foremost global reference rates for short-term interest rates of a variety of global financial instruments such as short-term interest futures contracts, forward rate agreements, interest rate swaps, and currency options. LIBOR is also a key driver in the eurodollar market and is the basis for retail products like mortgages and student loans.

They are derived from a filtered average of the world’s most creditworthy banks’ interbank bid/ask rates for institutional loans with maturities that range between overnight and one year.

50
Q

What Is the Difference between capital and money markets?

A
  • Short-term securities are traded in money markets whereas long-term securities are traded in capital markets
  • Capital markets are well organized whereas money markets are not that organized
  • Liquidity is high in the money market whereas liquidity is comparatively low in capital markets
  • Due to high liquidity and low duration of maturity in money markets, Instruments in money markets are a low risk whereas capital markets are the comparatively high risk
  • Central bank, commercial banks and non-financial institutions are majorly work in money markets whereas stock exchanges, commercial banks, and non-banking institutions work in capital markets
  • Money markets are required to fulfill the capital needs in short-term especially the working capital requirements and capital markets are required to provide long-term financing and a fixed capital for purchasing land, property, machinery, building etc.
  • Money markets provide liquidity in the economy where capital markets stabilize the economy due to long-term financing and mobilization of savings
  • Capital markets generally give higher returns whereas money markets give a low return on investments
51
Q

What is a bank based government structure?

A
  • banks provide finance to companies by owning large amounts of equity in them

European approach

52
Q

Who are the main provider of finance in the capital market?

A

Pension and mutual firms

53
Q

What is Globalisation?

A

Globalization is a process of interaction and integration among the people, companies, and governments of different nations, a process driven by international trade and investment and aided by information technology. … Likewise, for centuries, people and corporations have invested in enterprises in other countries.

54
Q

What are some key trend in Globalisation?

A
  • Population trends - Decreasing population in developed countries, while increasing population in developing countries, and increased life expectancy
  • Science and technology - Includes the Internet and other computer components as well as GPS, genetically modified food, etc.
  • Increasing integration and interdependence - Includes all areas of economic life as well as an increasing exchange of products and services across national borders through trade
  • Governance - How national and international laws govern the economic activity and transnational institutions.
55
Q

What are derivatives?

A

A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset (like a security) or set of assets (like an index). Common underlying instruments include bonds, commodities, currencies, interest rates, market indexes, and stocks.

56
Q

What are Paper Assets?

A

They refer to assets that are representations of something. Paper assets in investments literally are pieces of paper that define ownership of an asset. Classic examples of investing paper assets prove to be stocks, currencies, bonds, money market accounts, and similar types of investments.

For paper assets to have a tangible value, there must be a working financial system in order to back them up and exchange them. In the cases where a financial system collapses, paper assets commonly sharply decline along with it.

57
Q

What are Securities?

A

The term “security” is a fungible, negotiable financial instrument that holds some type of monetary value. It represents an ownership position in a publicly-traded corporation—via stock—a creditor relationship with a governmental body or a corporation—represented by owning that entity’s bond—or rights to ownership as represented by an option.

58
Q

What are Options?

A

Options are financial instruments that are derivatives based on the value of underlying securities such as stocks. An options contract offers the buyer the opportunity to buy or sell—depending on the type of contract they hold—the underlying asset. Unlike futures, the holder is not required to buy or sell the asset if they choose not to.

Call options –> allow the holder to buy the asset at a stated price within a specific timeframe.

Put options –? allow the holder to sell the asset at a stated price within a specific timeframe.

Each option contract will have a specific expiration date by which the holder must exercise their option. The stated price on an option is known as the strike price. Options are typically bought and sold through online or retail brokers.

59
Q

What are Forwards?

A

A forward contract is a customized contract between two parties to buy or sell an asset at a specified price on a future date. A forward contract can be used for hedging or speculation, although its non-standardized nature makes it particularly apt for hedging.

60
Q

What are Futures?

A

A futures contract is a legal agreement to buy or sell a particular commodity or asset at a predetermined price at a specified time in the future. Futures contracts are standardized for quality and quantity to facilitate trading on a futures exchange.

The buyer of a futures contract is taking on the obligation to buy the underlying asset when the futures contract expires. The seller of the futures contract is taking on the obligation to provide the underlying asset at the expiration date.

61
Q

What are Stocks?

A

A stock (also known as “shares” or “equity”) is a type of security that signifies proportionate ownership in the issuing corporation. This entitles the stockholder to that proportion of the corporation’s assets and earnings

62
Q

What are Coupon Bearing Bonds?

A

A coupon bond, also referred to as a bearer bond or bond coupon, is a debt obligation with coupons attached that represent semiannual interest payments. With coupon bonds, there are no records of the purchaser kept by the issuer; the purchaser’s name is also not printed on any kind of certificate. Bondholders receive these coupons during the period between the issuance of the bond and the maturity of the bond.

63
Q

What are zero coupon bearing bonds?

A

A zero-coupon bond is also known as an accrual bond or a pure discount bond

A zero-coupon bond is a debt security that does not pay interest but instead trades at a deep discount, rendering a profit at maturity, when the bond is redeemed for its full face value.

Some bonds are issued as zero-coupon instruments from the start, while others bonds transform into zero-coupon instruments after a financial institution strips them of their coupons, and repackages them as zero-coupon bonds. Because they offer the entire payment at maturity, zero-coupon bonds tend to fluctuate in price, much more so than coupon bonds.

64
Q

What is a consol?

A

Also known as perpetuities

These are rare

A perpetual bond is a fixed income security with no maturity date. This type of bond is often considered as a type of equity, rather than as debt. One major drawback to these types of bonds is that they are not redeemable. Given this drawback, the major benefit of them is that they pay a steady stream of interest payments forever. A perpetual bond is also known as a “consol bond” or a “perp.” –> unique to the UK

65
Q

What are the Functions of Financial Markets?

A
  • Borrowing and Lending
    • Financial markets permit the transfer of funds (purchasing power) from one agent to another for either investment or consumption purposes.
  • Price Determination
    • Financial markets provide vehicles through which prices are set both for newly issued financial assets and for the existing stock of financial assets. By setting the prices paid for financial assets they also set rates of interest on these assets
  • Information Aggregation and Coordination
    • Financial markets act as collectors and aggregators of information about financial asset values and the flow of funds from lenders to borrowers.
  • Risk Sharing
    • Financial markets allow a transfer of risk from those who undertake investments to those who provide funds for those investments. Because financial institutions provide funding to a range of clients, there is also a pooling of risk.
  • Liquidity
    • Financial markets provide the holders of financial assets with a chance to resell or liquidate these assets.
  • Efficiency
    • Financial markets reduce transaction costs and information costs
66
Q

What are the main characteristics of an asset?

A
  • Divisibility: it refers to the extent to which fractional amounts of an asset can be either bought or sold. E.g., equity can be divided into a number of stocks (in general, financial assets are viewed as divisible).
  • Liquidity: it refers to the speed with which an asset can be sold (this is where the term ‘maturity’ comes into play).
  • Standardization: given the multiple uses of financial assets, it is not surprising that financial agreements are costly to be made, maintain, and monitor. Standardization determines and promulgates criteria to which financial assets are expected to conform.
67
Q

What are Economies of Scope?

A
  • a function of financial intermediaries
  • reduce the cost of information production for each service by applying one information resource to many different services –> credit risk evaluation on a corporation loan can help an investment bank decide how much an easily they could sell bond of the company to the public

Although having all of this information creates a conflict of interest such as concealing information on a company’s credit risk to help the bond department dealers sell more bonds

68
Q

What can regulatory authorities and the government do to reduce financial panic?

A
  • Restriction on Entry –> meet strict criteria to become a bank
  • Disclosure –> reduce information asymmetries
  • Restriction on Assets and Activity –> cant take risky gambles with people pensions
  • Deposit Insurance
  • Limits on competition –> politicians argue too much competition is bad for the consumer (although evidence sats this is only minor) - cant open branches in some locations
  • Restrictions on Interest Rates - stops banks competing heavily on interest rates
69
Q

What is the MPC goal with interest rates?

A

to deliver price stability and to support the government’s economic objectives including those for growth and employment

70
Q

What is the Case for Central Bank independence?

A
    • to avoid potential inflationary biases that are likely to exert themselves as a result of political pressure to boost output in the short run - mainly before the election, in order to finance government spending to lower unemployment and interest rates.
  • public distrust politician (principal-agent problem), combined with their lack of knowledge in economics. While the central bank can also do this it is worse for politicians who have less incentive to act in favour of public interest
  • In cases of disagreement about public policy, politicians can give the central bank more independence in order to avoid public criticism.
71
Q

What is the Case against Central Bank independence?

A
  • achieve macroeconomic targets and stability when monetary policy is properly coordinated with fiscal
  • just like politicians the central bank can pursue a course of narrow self-interests to increase its power and prestige at the expense of public interest