8.1 structure of financial markets and financial assets

money is

a system of value that facilitates the exchange of goods and services in an economy, and also acts as a store of value

characteristics of money are

divisible, portable, homogenous, durable

functions of money are

medium of exchange, store of value, means of deferred payment, unit of account

money is divisible

because it can be broken down into smaller units without loosing its value, facilitating transactions of various sizes, also allows for psychological pricing

money is durable meaning

its value doesn’t deteriorate overtime and ensures currrency remains valuable

money is a medium of exchange meaning

it can be used to pay for goods or services, settling transactions and for the payment of debts since we live in a monetary economy and can trade with the intermediary of money rather than barter

bartering is

when goods and services are exchanged directly and requires the double coincidence of wants

money is a store of value or wealth

since it is an asset, and therefore allows saving as its purchasing power is transferred to the future, however overtime inflation can erode moneys purchasing power

money is a means of deferred payment

meaning it allows for debts to be created and people can pay for things without having the money in the present, this is reliant on money storing its value

money is a unit of account

as it provides a means to measure the relative value of different goods and services, it also allows a value to be put on labour

the evolution of money overtime has

gone from barter, commodity money, metallic money, paper money, gold standard, fiat money, digital money and crypto

commodity money is

items like shells, beads, cattle, slaves and precious metals, used 9000BC

metallic money is

gold and silver coins being used due to early chinese metal tools, 1000BC-700BC

gold standards was

currencies backed by gold reserves, in the 19th century

fiat money is

a government issued currency authorised to be legal tender

advantages of fiat money are

central bank control (monetary policy, inflation rates, interest rates), insulation in booms and busts, less costly to produce than commodity produced money

disadvantages of fiat money are

hyperinflation by printing too much, lack of scarcity since there is no inherit limit, bubbles and speculation

advantages of gold standard are

price stability, stable exchange rates, credibility and confidence

gold standard gave price stability since

the amount of gold was relative stable, the government also couldn’t create excess money and create artificial inflation, giving confidence in financial system

gold standard created stable exchange rates

meaning there was greater certainty for international trade

disadvantages of gold standard are

no flexibility in recessions, deflationary bias when the economy grows faster than the gold supply increasing real debt burdens and the ability of firms to invest and households to invest, dependant on gold supply

digital currencies are

digital versions of official currencies issues and backed by central banks

advantages of central bank digital currencies are

they are efficient, fast and tradeable, decrease reliance on private digital currency, increased monetary policy effectiveness

disadvantages of central bank digital currencies are

could disrupt commercial banks, privacy concerns, cybersecurity risk, implementation costs and complexity

central bank digital currencies could disrupt commerical banks through

disintermediation- competing with commercial banks intermediate role such as bank deposits, can facilitate bank runs

cryptocurrency is

a decentralised virtual currency based on blockchain technology

blockchain is

when each transaction is grouped into a block which are linked together in chronological order forming a chain ensuring transparency and security, all transactions are publicly accessible and they cannot be altered once recorded

pros of cryptocurrencies are

faster and cheaper transaction, decentralisation, transparency and security, portfolio diversification, protection from inflation

crypto allows faster and cheaper transaction because

payments can be sent globally quickly and with lower fees than banks

crypto has more transparency and security since

all transactions are recorded publicly on blockchain which decreases fraud and errors

crypto allows portfolio diversification by

enabling investors to spread their investments across a range of digital assets instead of relying on a single coin, helping to manage risk and capture growth

cons of crypto are

extreme volatility, lack of regulation, environmental concerns, no refunds or FCSA

crypto has extreme volatility

due to lack of liquidity meaning supply and demand can change rapidly, regulatory uncertainty can drive market volatility, and heavily influenced by speculative behaviour

environmental concerns that come with crypto are

significant energy consumption, carbon emissions, electronic waste which come with crypto mining

crypto has no refunds or FCSA

meaning rights are no protected and there is no financial services compensation scheme whereas banks are protected up to £120,000

the money supply is

the stock of currency and liquid assets in an economy, including cash and money in savings

narrow money is

the part of the stock of money made if cash and liquid bank and building society deposits

broads money is

the entire money supply it is part of the stock of money made of cash, other liquid assets such as bank and building society deposits, and some less liquid assets

the different classification/names of the money supply used by bank of england are

M0,M1,M2,M3,M4 M0,1,2 encompass narrow money, M3,4 encompass broad money

near money is

highly liquid financial assets that can be quickly converted to cash with minimal loss of value, it is considered M4

entire money supply inclusions from narrow to broad on a spectrum are

notes and coins (M0), checking accounts (M1), savings and credit default services (M2), larger deposits, institutional money, larger liquid assets, near money (M4), non cash financial assets with less than 5 years to maturity

liquidity is

the ease with which an assets can be converted into cash without the loss of value

quantitative easing has a time lag because

it is done by broad money channels meaning it takes time to feed down into more liquid channels

equity is

wealth, or the value of a share

equity markets

involve the trade of shares, also known as the stock market and they provide access to capital for firms and allow investors to own a part of a market

debt is

money that has been borrowed from a lender and there is little flexibility, the loan is later repaid with interest

when choosing what assets to hold people have to make

portfolio balance decisions

parts of portfolio balance decisions include

whether to have physical assets, or financial assets, whether in financial assets to maintain liquidity or profitability

examples of physical assets include

houses, land, art, antiques and they can be attractive since they tend to go up in value

financial assets invlude

cash, bank deposits, gilts, shares on a scale from liquidity to profitability

bonds are

financial securities sold by companies or by government which are a form of long term borrowing, they usually have a maturity where initial investment is repaid and borrower earns fixed interest payments each year

a gilt

refers to a bond issued by the UK government

to calculate the flat yield of a bond

coupon/market price x 100

to calculate yield to maturity of a bond

coupon-capital losses/gain / market price x 100

the yield to maturity represents

the cost of borrowing for the government and the real interest rate for investors

longer term bond needs more attractive coupon rates

to shield against inflation

goodharts law is

when a measure becomes a target it, it ceases to be a good measure basically saying that once a measure of performance is used as a target its reliability as an indicator is compromised

financial markets are

markets in which financial assets or securities are traded, they act as intermediates between lenders and borrowers better facilitating the flow of capital in the economy

the reward for those who engage in financial markets are

interest and returns

lenders in financial markets are

savers or investors

borrowers in financial markets are

individuals, firms, the government

three type of financial markets in the UK are

money markets, capital market, currency market

a money market

provides means for lenders and borrowers to satisfy their short-term financial needs, it focuses on lending with more liquid assets like short-term loans with maturities from days to a year and are normally easily convertable into cash

capital markets

are where securities such as shares and bonds are issues to raise medium to long term financing, it focuses on lending with less liquid assets which are traded on the second-hand part of the market such as the london stock exchange

foreign exchange markets or currency markets are

global, decentralised markets for the trading of currencies, with the main participants bing large international commerical banks, and collectively are the largest markets in the global economy

examples of things sold on the money market are

commercial bills by the private sector, treasury bills by the government

commercial bills are

sold by investment banks on behalf of client firms, in promise to pay a specified amount by a specific future date, normally around 3 months

treasury bills are

sold as new issues by the Bank of England on behalf of the government providing them with a method of financing the differences that emerge at certain time of the financial year between tax revenues and government spending

examples of things sold on capital markets are

shares, corporate bonds, government bonds

shares are

undated financial assets, sold initially by a company to raise financial capital, a share signifies the the holder owns part of the enterprise

corporate bonds are

debt security issues by a company and sold as new issues to people who lend long-term to the company, they can usually be resold second hand on a stock exchange

government bonds are

debt security, in the UK known as gilt-edged securities or gilts, issued by a government and sold as new issues to people who lend long-term to the government, they can be resold second hand on the stock exchange

the role of financial markets in the wider economy are

to facilitate saving, to lend to businesses and individuals, to facilitate the exchange of goods and services, to provide forward market in currencies and commodities, to provide a market for equities

financial markets profivde forward markets in currencies and commodities because

currency markets can have speculative attacks taken on them, which can affect the value of the exchange rate, and it involves buying or selling an assets with an agreed price in the present, but delivery and payment is in the future

a forward market is

an informal financial market where contracts for future deliveries are made

the relationships between bond prices and interest rates are

inverse

a coupon is

the guaranteed fixed annual payment, often divided into two 6-month payments, pai by the issue of a bond to the owner of a bond

maturity date is

the date on which the issuer of a dated security, such as a gilt edged security or a treasury bill pays the face value of the security to the securities owner

the relationships between bond prices and interest rates are inverse because

if you buy a £100 bond from the government with a coupon of £5 the interest rate is 5%, if the bond price increases is £200 and is sold on stock exchange, the coupon is still £5 therefore new interest rate is 2.5%, so the bond price increased and interest rate decreased. moreover newly issues bonds have rates close to the market interest rate, if a bond is bought and the market interest rate falls, the bond will be worth more since it carries a higher interest rate than the current market rate

capital gains and capital losses affect share prices

as the expectation of making a capital gain or fear of suffering a capital loss leads to speculative behaviour, in the speculation of making a capital gain demand for a bond will increase at its current price in hope of it rising shortly and a capital gain being able to be made, therefore pushing the price up. vice versa

capital markets are split into two parts which are

the new issues markets an the second hand market

the new issues market is

the primary market where shares are sold for the first time, it is where companies raise new capital and they are rarely sold directly on the london stock exchange instead the direct sale to the general public is usually arranged by investment banks

the second hand market

involves the London stock exchange and has an important economic role as it makes shares to be more liquid and converted into cash more easily, without it the general public would be reluctant to buy shares that could not be easily resold

foreign exchange markets can take place either on

the spot market or the forward market

spot market is

transactions that involve the immediate exchange of foreign currency