Financial Markets

What are financial markets?

Places where buyers and sellers can meet to trade financial assets

Give 2 examples of financial markets

1. Stock markets

2. Bond markets

What is the purpose of a financial market?

To bring two important groups of people together: lenders and borrowers

Who are lenders?

Individuals with excess cash(i.e., those who have money)

Who are borrowers?

Individuals who require money but do not currently possess it

Give 2 examples of lenders

1. Savers

2. Investors

Give 3 examples of borrowers

1. Individual consumers

2. Firms

3. The government

Provide 2 ways in which lenders can lend money to borrowers

1. Lenders can go to the bond market, specifically the Debt Management Office in the UK, to purchase government bonds, lending money to the government.

2. Lenders can also go to the stock market to buy shares of different firms: known as equity capital for companies

Provide 5 examples of intermediaries

1. Commercial banks

2. Investment banks

3. Pension funds

4. Hedge funds

5. Mutual funds

How does a commercial bank function and how does it make profits

1. Firstly, a commercial bank will store the savings of lenders such as investors and savers looking to gain a higher rate of return as a credit for their savings.

2. The commercial bank will then use these savings to loan out money to borrowers such as individual consumers who desire to pay their mortgages and firms looking to invest and grow their company.

3. The commercial bank would make profits by charging a higher rate of interest on the money loaned to borrowers and providing lenders a lower rate of return on their savings.

How do pension funds operate?

1. Pension funds take large sums of money from individual workers who desire to save money to be later used when they retire.

2. Such pension funds then invest this money in the stock market and then pay the newity to pensionars when they reach the retirement (pension) age.

How do hedge funds and mutual funds operate?

1. Hedge funds and mutual funds take large sums of money from lenders, specifically investors, and use this money to buy huge sums of debt from borrowers.

2. Hedge funds and mutual funds then charge a high rate of interest on the money they loaned to borrowers while offering lenders(investors) a smaller rate of return as a credit for their savings, thereby making profit.

What is the difference between hedge funds and mutual funds

1. Hedge funds operate in riskier transactions than mutual funds, such as purchasing debt in very heavy, very risky leverage deals, while mutual funds would not be involved in such leverage deals. This is because if the transaction in leverage deals goes wrong, then large sums of money will be lost by the first party.

2. Moreover, there is less regulation in mutual funds than in hedge funds where there is much more regulation