2.8 - The Role of Money and Financial Markets

The Role of Money and Financial Markets

what are bank deposits

the current accounts and savings accounts you have

why are cheques and debit and credit cards not money

they are a way of transferring money between buyers and sellers

what is the financial sector

consists of financial organisations and involves the fow of capital

what are the 3 key financial institutions

banks building societies and insurance companies

what does the central bank do (in the UK it is the Bank of England)

it is the heart of the banking system and sets the base rate that impacts other financial institutions and is the bank for commercial banks and the government

what do retail / commercial banks do

they are there ro make sure money is used efficiently within the economy - when you save the banks use that money to help businesses invest

how do banks make money

by charging a higher interest rate for borrowers than they pay to savers

what is a building society

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

what are insurance companies

financial institutions that guarantee compensation for specified loss damage illness or death in return for an agreed premium

what is money

anything that is generally acceptable as a means of payment for goods and services. it is a medium of exchange and sets the standard if value of goods and services acceptable to all parties

what are the three main important roles the financial sector has

credit provision liquidity provision and risk management

what is credit provision

credit provision refers to the process of providing loans or credit to individuals or businesses. this ‘oils the wheels of the economy’ because without credit the economy gets stuck

what is liquidity provision

how easy it is to turn an asset into cash. banks are the main providers of liquidity to households and businesses

what is risk management

the financial sector allows the pooling of risk and this should encourage more savings and investments

why is credit provision important for consumers

they can buy now and pay later which increases consumption

why is credit provision important for producers

they can borrow money to expand their business

why is credit provision important for government

can run a budget deficit or spend before taxes are collected

why is liquidity provision important for consumers

they can borrow to pay later often against an asset like a house e.g. remortgaging a house

why is liquidity provision important for producers

banks will provide overdraft facilities so firms can continue trading while waiting for payments

why is risk management important for consumers

allows savers to spread their risk by putting their money into a range of companies rather than just one e.g. insuring their items

why is risk management important for producers

reduces risk of not receiving payment especially when exporting or not receiving on time

why is risk management important for government

allows for vital expenditure even when revenue is uncertain

what are interest rates

the reward for saving and the cost for borrowing as it is the percentage rate paid on savings or borrowings

what is the base rate or the bank rate

the interest rate charged to banks for borrowing from the central bank and this rate then impacts the interest rates set by the high street banks

what is the annual equivalent rate

the amount of interest a savings account will earn in a single year

what is gross annual

the annual income from a savings account that is earned before tax is deducted

what is compound interest

where a savings account starts to earn by receiving interest payments from the interest already earned from the account

what is access

different banks will allow different levels of access to savings for example some banks will let holders instantly withdraw any amount however other accounts may only allow the holder to withdraw after they have given notice they wish to do so

what is the basic relationship between savings and interest rates

the population will save more at a higher interest rate and less at a lower interest rate because the higher the interest rate is the higher the return will be

why won’t the relationship between savings and interest rates always hold

confidence as those reliant on savings might save more or use alternative sources for savings such as stocks and shares

what is the basic relationship between borrowing and interest rates

the population will borrow more at a lower interest rate and less at a higher rate because borrowing costs less at a lower rate so it is affordable to borrow more

why does the relationship between borrowing and interest rates not always hold

when people save more they spend less so firms don’t feel the need to borrow money to expand their firm if people are not buying enough from it

what is the basic relationship between investment and interest rates

the population borrows more at a lower interest rate meaning there is more investment

what is investment

purchase of capital goods that are used to produce future goods and services such as machinery