2.8 - The Role of Money and Financial Markets

What is money?

Anything that is generally accepted as a means of payment for goods and services.

Explain debit cards.

• A card which allows money, in the form of banks deposits in current accounts, to be transferred between buyers and sellers.

• If you don't have enough money, you can't buy the product.

• There is no charge to the seller for accepting these cards in payment.

Explain credit cards.

• They enable the holder to spend money now and to pay it back at a later point in time.

• If you cannot pay it all back, you are interest on the amount outstanding.

• Retailers are charged for allowing you to use these cards in payment.

Are cheques, debit cards, and credit cards, money?

No.

What is barter?

The ‘double coincidence of wants' , or the need to find someone who has products you want and is willing to exchange for your goods and services.

Can you barter with money?

No.

What is a medium of exchange?

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

Why is money a medium of exchange?

Because it's generally accepted as the means of buying and selling products.

What is the financial sector?

The financial sector consists of financial organisations and their products and involves the flow of capital.

What does the financial sector do? How?

It helps markets to function and consumers, firms, and governments to carry out economies activities.

• This is usually done through the lending and borrowing of money, both in the short and long run.

• This is done by financial intermediaries.

  • Banks

What do financial intermediaries do?

They link consumers, firms, and governments in allowing money to be moved from those who do not need to use it immediately (savers) to those who want to use it now (borrowers).

Why is banks lending savers’ money to borrowers important?

• It allows for a good use of all funds.

• Adds to the efficient organisation of the economy.

A healthy financial sector is important for a stable economy.

Give examples of financial institutions.

• The central bank

• Commercial banks

• Building societies

• Insurance companies

What is the role of central banks?

• Issuing bank notes.

• Control monetary policy by setting the bank rate.

• Provide financial stability.

• Manage the country's foreign reserves.

• Act as the bank for the commercial banks.

• Be the bank for the government.

What is the bank rate?

The interest rate set by the Central Bank, from which all other interest rates are calculated.

What is the basic role or commercial banks? How is this done?

To take savings/deposits from customers and to turn them into assets for the banks.

• This is done by investing or lending savers' money.

• This makes the bank gain a higher rate of interest than that which they are paying savers.

What are the general rates of interest commercial banks give compared to base rate?

• Savers - lower than base rate

• Borrowers - higher than base rate

What do commercial banks do?

• Accept deposits and pay interest on them.

• Keep savings safe.

• Make payments on behalf of their customers by cheque, card payments, etc.

  • This is important as fewer notes and coins are used for purchases now.

• Issue loans to individuals and firms.

• Provide overdraft facilities.

• Offer safe deposit boxes for very expensive items.

What are loans?

Amounts of money that a bank gives a customer for a set period of time, on which interest is charged.

What are overdrafts?

When a bank allows a current account holder to use money even though it is not in their account.

What are building societies?

Mutual institutions where their members, the people who save money with them, own them.

What rights do building societies’ members have in the societies?

• Rights to attend and speak at meetings.

• To vote on issues.

• Each member has one vote, regardless if their invested or borrowed money.

What is a mortgage?

A mortgage is a financial agreement to borrow money in order to purchase a house.

What do building societies do?

Provide ssavint products and mortgages for their members.

How are building societies different from banks?

• Banks are normally public limited companies.

• Banks are normally listed on the stock market.

• Banks are owned by shareholders who have voting power in line with the number of shares they own.

Are building societies limited to the amount of money they can borrow from the money market?

Yes.

What are insurance companies?

Financial Institutions that guarantee compensation for specified loss, damage, illness, or death in return for an agreed payment (called premiums).

What are the two main functions of insurance companies.

• Life Insurance

• General Insurance

What does life insurance do?

Pays out money to the surviving family if the person insured dies.

What are the two policies of life insurance?

• Whole-of-Life

  • Paid out whenever the person dies as long as the premiums have been paid.

• Term Life Insurance

  • Cover the person for a specific period only.

What is general insurance?

Insurance which covers all non-life policies.

Includes:

• Property

• Contents

• Motor

• Health

• Pets

• Etc.

Why is life insurance helpful?

Intended to help replace the loss of income due to the death of the person insured.

What do general insurances help with?

Spreads the risk of loss across all insurwnce holders.

What are the three main roles of the financial sector?

• Credit Provision

• Liquidity Provision

• Risk Management

How does credit provision affect consumers?

• Allows them to live beyond their means and run up very large debts.

• Allows them to buy now and pay later, increasing consumption.

• The provision of mortgages allows far more consumers to buy their own home.

How does credit provision affect producers?

• They can borrow money from financial institutions to enable them to grow, without having to first save all the necessary money.

How does credit provision affect governments?

• Enables them to spend money even when tax revenue hasn't yet been collected.

• Enables them to spend more than they intend to raise in taxes.

How does liquidity provision affect households and businesses?

Allows them to continue to function when faced with unexpected demands for cash.

• Overdrafts

How does the risk management role affect individuals and businesses?

Allows them to pool their risks from exposure to financial markets.

• A professional finance manager will take savings from a range of customers and invest in a range of companies.

  • This ensures that if one does less well, the savers will not lose all their money.

How do interest rates affect the level of saving?

• A rise in interest rates offered to savers will encourage people to increase their level of savings.

• A fall will result in people reducing their levels of savings.

How do interest rates affect the level of borrowing?

• Higher interest rates increase the cost of borrowing.

  • Both firms and individuals will borrow less.

• Individuals will be encouraged to save rather than spend with a rise in interest rates.

  • They will purchase fewer goods/services.

  • This deters firms from borrowing as their revenue will fall.

• A rise will 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 reduce borrowing.

How do interest rates affect the level of investment?

• A fall in the rate of interest means that:

  • the cost of borrowing has gone down - cheaper to borrow for investment.

  • Lower opportunity cost involved in sacrificing saving.

  • Consumers are encouraged to spend and therefore, firms will want to expand in order to meet this expended rise in demand.

• The level of investment is inversely related to the rate of interest.

• If firms and consumers lack confidence in the economy, firms ight not increase investment, as they do not expect more demand.