Financial markets and monetary policy - Macro economics

What is money?

Anything generally accepted in payment of debt; solves the problem of barter.

What are the key characteristics of money?

Acceptable, portable, durable, divisible, scarce, and hard to counterfeit.

What are the four functions of money?

Medium of exchange, unit of account, store of value, standard for deferred payment.

What is the money supply?

The total stock of money available for transactions in the economy.

What is liquidity?

The ease with which an asset can be converted into cash.

What is the money market?

The market for short-term, highly liquid borrowing and lending.

What is the capital market?

The market for long-term debt and equity finance (e.g. bonds, shares).

What is the foreign exchange market?

Where currencies are bought and sold for trade and investment.

What is a financial asset?

A claim to future income (e.g. stocks, bonds, ETFs).

What is a bond?

A debt instrument where the issuer pays interest to the holder.

What is a stock?

Ownership share in a company; may pay dividends.

What is a derivative?

A financial contract based on the value of another asset (e.g. option).

what is financial market

buyers and sellers come together to trade financial assets, such as stocks, bonds, currencies etc. Main goal is to match buyers and sellers

What are the key roles of financial markets?

• allow households and businesses to save - secure and can earn interest

• to lend to businesses and consumers

• to allocate funds to productive uses

• manage risk.

What is the difference between equity and debt?

Equity is ownership with dividends; debt is borrowing with interest repayments.

What is a commercial bank?

A bank providing everyday financial services like loans, deposits and accounts.

Functions of commercial bank

• accepting deposits - offer safe and easily accessible deposit accounts

• providing loans - extend credit to individual and businesses

• payment services - facilitate payment and fund transfer services

• safekeeping of valuables

• currency exchange

How do banks create money

Fractional reserve system - banks keep a fraction of deposits and lend out the rest.

Money multiplier effect - Re-lending of deposits increases the money supply across the banking system.

What is credit creation? Banks create new money by lending, which expands deposits and boosts GDP.

Main roles of a central bank

• monetary policy - central bank set interest rates and controls money supply

• financial stability - central banks work to ensure the stability of the financial system by regulating banks and other financial institutions.

• managing the currency: central banks print and issue currency

• lender of last resort - central banks act as a lender of last resort, providing emergency loans to banks and other financial institutions

central bank = the governments bank

• issuing government bonds: central banks can issue and sell gov bonds on behalf of the gov to finance its budget and borrow money

• managing gov debt: central banks can help gov manage their debt and selling gov bonds in the market, helps stabilise prices and maintain liquidity

• providing advice: central banks often provide financial and economic advice to governments, helping them to make informed decisions.

why is regulation important?

• preventing systematic risk: helps reduce risk of major financial crisis by requiring financial institutions to maintain adequate capital and liquidity

• protecting consumers: protects from fraud, predatory lending and other harmful practices

• ensuring fair price competition: promotes fair competition in financial industry by preventing anticompetitive behaviour and unfair pricing practices

• promoting financial stability; prevent kind of market instability that can lead to economic downturns and recessions

What is asymmetric information?

When one party in a transaction has more information than the other.

What is moral hazard?

When firms take excessive risks believing they’ll be bailed out if things go wrong.

What is a financial crisis?

A major shock to the financial system causing economic instability (e.g. banking crash).