Financial Markets

Explain one role of financial markets  (2)

Savings/lending 

K-To mobilise savings 

K-for lending to businesses and individuals to invest or consume  

Currency 

K-To facilitate the exchange of goods and services  

K-By providing a flat currency  

Forward markets 

K-To provide forward markets in currencies and commodities  

K-To reduce risk 

Equities  

K-To provide a market for equities  

K-To facilitate raising of finances by businesses  

Explain one reason why the UK central bank used quantitative easing following the Global financial crisis 2008 (2) 

K-To stimulate growth  

K-By increasing money supply  

 

K-to increase bank liquidity  

K-so they will be more willing to lend  

 

K-interest rates were already very low  

K-so limited scope for further decisions  

 
K-prevent deflation  

K-by increase in money supply 

with reference to extract A, explain the role of forward markets in currencies (5) 

2K-Firms agree a fixed price for purchase of foreign currency in the future 

Ap- “Buying currency as soon as a large order is confirmed” 

An- Nielsen Bainbridge get a guaranteed price, meaning that they have the security of knowing exactly what they will have to pay. 

Ap- “depreciation has been a test of nerve for Nielsen Bainbridge and many other importers” 

An- Nielsen Bainbridge can reduce the risk and uncertainty of import costs in pounds, which helps firms’ decision making.

With reference to the information above, explain what is meant by ‘market rigging’ (4) 

2K-Market rigging occurs when firms unfairly try to control prices (possibly by providing inaccurate information) which distorts the price mechanism.  

Ap- “share information about customers’ orders (...) to manipulate the currency markets” 

An- due to market rigging, prices were no longer correctly determined by Price mechanism and consumers lose out due to rates/prices not being where they would be in a Competitive market 

 

Role of central bank

1. Lending to other banks (lender of the last resort) 

2. Lending to the government 

3. Implementing monetary policy by manipulating the base interest rate and the money supply

4. Regulating the banking industry 

Systemic risk

Potential for failure in one or more parts of the financial system can lead to widespread disruption across the whole sector. 

Can happen as one event causes a large number of financial institutions/markets to become illiquid, and become susceptible to bank runs

 Regulation to lower systemic risk  

1. Capital and liquidity requirement (required to hold reserves) 

2. Ring fencing; UK regulations that forces banks with over 25 billion in commercial deposits to separate their investment and commercial banking operations.

3. Stress Testing; Bank of England simulates different extreme but plausible scenarios to see if banks can survive. Helps regulators to spot any weaknesses that could lead to systemic risk 

4. Banks must have recovery plans that specifically outline their responses to times of hardship  Eg. Selling assets