2.8 - the role of money and financial markets

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money \[term\]

anything that is generally accepted as a means of payments for goods and services

financial sector \[term\]

consists of financial organisations and their products, and involves the flow of capital

investment \[term\]

the purchase of capital goods that are used to produce future goods and services. Also an asset purchased to provide an income in the future and/or to be sold at a profit

medium of exchange \[term\]

anything that sets the standard of value of goods and services acceptable to all parties involved in a transaction

rate of interest/ interest rate \[term\]

the cost of borrowing money i.e. that which is paid to the lender. it is also the reward for saving

building society \[term\]

a mutual financial institution that is owned by its members. its primary objectives are to receive deposits from its members and to lend money for members to purchase property

mortgage \[term\]

an agreement with a financial institution to borrow money to purchase a property

insurance company \[term\]

financial institution that guarantees compensation for specified loss, damage, illness or death in return for an agreed premium

debit cards

take money directly from your current account and transfer it to the seller. if you do not have enough money in your account, you cannot buy the product.

there is no charge to the seller for accepting these cards in payment

credit cards

Enable you to buy goods whether or not you have the money in your account, i.e. a loan for up to 30 days. if you cannot pay it all back, you are charged interest on the amount outstanding.

retailers are charged for allowing you to use these cards in payment

what are the three main roles of the financial sector

* credit provision
* liquidity provision
* risk management

credit provision

* Without credit the level of economic activity in an economy would be greatly limited 
* Financial institutions provide a way for consumers to buy now and pay later → therefore increasing consumption 
* Mortgages allow people to only pay a small percentage of the cost of housing → this gives more people the ability to buy their own home 
* Producers can borrow money to enable them to grow 
* Governments used credit to enable them to spend money when tax revenue has not yet been collected or when they wish to spend more that they intend to raise in taxes 

liquidity provision

* Liquidity refers to how easy it is to turn an asset into cash 
* Banks are the main providers of liquidity to households and businesses → this allows them to continue to function when faces with unexpected demands for cash 
* For example banks offer an overdraft facility 

risk management

* Financial institutions allow both individuals and businesses to pool their risk from exposure to finances 
* A professional finance manager will take savings from a range of customers and invest the money in a range of different companies 
* This means that if one company is not doing very well then the savers do not lose all of their money as the other business will be probably doing much better 
* This is much less risky than saver putting their money into one firm on the stock exchange 

higher interest rates increase the cost of borrowing

individuals and firms tend to borrow less this is because not only is new borrowing more expensive but also people have to pay more on they already borrowed 

higher interest rates might encourage individuals to save

as a result they will purchase fewer goods and services this will purchase fewer goods and services this will further deter firms from borrowing as their revenue will fall 

higher interest rates is likely to lead to an increase in the foreign exchange value of the pound

If the pound rises, exports are less competitive so firms will sell less and once more reduced borrowing Rises of quantity of money borrowed falls from q to q1 

what do higher interest rates lead to

* less borrowing
* more saving
* increase in foreign exchange value of pound

what is the relationship between the level of investment and rate of interest

they are inversely related

how do low interest rates affect firms

Lower interest rates will also encourage consumers to spend and therefore firms will want to expand in order to meet the expected rise in demand 

But if there is a lack of confidence in the economy from consumers, firms might not increase investment as they do not expect more demand 

how does a fall in interest rates affect consumers

not only that the cost of borrowing has gone down so therefore it is cheaper to borrow for investment bit also that there is a lower opportunity cost involved in sacrificing saving