LC Economics- The Financial Sector

What are the 2 types of finance provided by financial markets?

Short term- typically provided for up to one year

Long term- provided for more than a year e.g. bonds

What are the types of financial markets?

Money markets- short term finance: treasury bills

Capital markets- long term finance: trading of bonds and shares

Foreign exchange markets- different currencies are traded

What are the roles of the financial markets?

• to facilitate saving

• lend to businesses and individuals

• facilitate exchange of goods and services

• provide forward markets in currencies and commodities

• provide a market for equities

What is meant by facilitate savings?

storing money for future use is essential for households and firms. It also provides a pool of money that financial institutions can lend i.e. one person's savings is another person's borrowing

What is meant by lending to businesses and individuals?

access to credit is a key requirement for economic growth and development. Being able to borrow money speeds up consumption by households and investment by firms. It also allows households or firms to purchase assets and pay them off over an extended period of time e.g. mortgages on home purchases

What is meant by facilitate the exchange of goods and services?

each purchase of goods/services requires the movement of money between at least two parties. Financial markets provide multiple ways for this exchange to happen including phone apps (Google Pay), debit cards, credit cards and bank transfers

What is meant by providing forward markets in currencies and commodities?

forward markets are also called futures markets. They provide some price stability in commodity markets and enable investors to make a profit by speculating on future prices

What is meant by providing a market for equities?

equities are shares in public companies that are listed on stock exchanges around the world. Financial markets facilitate both long term investment and speculation by providing platforms which connect buyers and sellers e.g. E-Trade

stock market

What is market failure in the financial market?

When free markets fail to deliver an efficient or socially optimum allocation of resources.

What are some examples of market failure in the financial markets?

Asymmetric information

Externalities

Market rigging

Speculation and market bubbles

Moral hazards

How is asymmetric information market failure?

Many financial products are complex and difficult for consumers to understand

How are externalities market failure?

Negative externalities of production and consumption exist in financial market

E.g. When investors speculate on property prices, a negative consumption externality occurs as young buyers end up paying more (or being forced out of the market) due to the higher prices caused by speculation (AirBnB effect)

How is moral hazard market failure?

When someone is more willing to take risks because they understand that someone else will pay any costs if anything goes wrong. Excessively risky behaviour

How are market bubbles and speculation a market failure?

speculation- buying at a low price and selling at a higher one. Aim is to make profit based on risk

Market bubbles- when the price is forced up (inflationary pressure) due to increased demand (herd behaviour) investors sell in panic which leads to the price falling extremely low

How is market rigging a market failure?

When individuals collude to fix prices or exchange information to help make gains at the expense of others (insider trading)

What is the LIBOR scandal?

In summer 2012, banks were falsely inflating and deflating the rates they claimed to be profiting from trades or to give the impression that they were more credit worthy than they were.

What are the functions of a central bank?

-Implementation of monetary policy

Banker to the government

-Banker to banks- lender of last resort

-Role in regulation of the banking industry

What is meant by banker to the government?

The Government sets the annual budget but it is the Central Bank that manages the tax receipts and payments, Manages national debts via bonds and short term loans

What is meant by lender of last resort?

Stabilises the banking system.Commercial banks are able to borrow from the Central Bank if they run into short-term liquidity issues. Without this help, they might go bankrupt leading to instability in the financial system - and a potential loss of savings for many households

What is meant by regulation of the banking industry?

Regulation is in place to prevent systematic risk e.g

-Reserve requirements

-Ensuring that competition exists

-Ensuring that financial rules are adhered to via fines and penalties