2.8 The Role of money and financial markets

What is the medium of exchange

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

E.g. money is a medium of exchange

Define interest rate

The cost of borrowing money

I.e. that which is paid to the lender and also rewarded to savers

Define investment

The purchase of capital goods that are used to produce future goods and services.

It is also an asset purchased to provide an income in the future and/or to be sold at a profit

5 roles of the central bank

1. To issue bank notes

2. To control interest rates by setting a bank rate which all other interest rates are based off of.

3. Provide financial stability - so citizens can trust financial organisations

4. To manage country’s foreign reserve

5. To act as the bank for commercial banks and government

What is a deposit

A deposit is the act of placing cash with some entity, most commonly with a financial institution, such as a bank.

4 Main Roles of commercial banks

1. Accept deposits and pay interest on them whilst also keeping savings safe

2. Make payments on behalf of customer to allow them to use cheques and card payments as fewer notes/coins being used for purchases

3. Issue loans to individuals and firms and provide overdraft facilities

4. Offer safety deposit boxes for very expensive items like jewellery and also provide foreign currencies for firms and individuals.

What is a loan?

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

What is an overdraft?

Overdrafts are when a bank allows a current account holder to use money even though it’s is not in their account. This should be agreed beforehand and interest is charged on the amount owing on a daily bases. E.g. credit cards

What is a building society?

A mutual financial institution that is owned by its members. It’s primary objectives are to receive deposits from its members and to lend money for members to purchase properties

What is a mortgage?

An agreement with a financial institution to borrow money to purchase a property.

What is an insurance company?

Financial institutions that guarantees compensation for specified loss, damage, illness or death in return for an agreed premium.

what is the importance of credit provision for consumers, producers and governments

• Consumers: Increases economic activity and allows them the ability to buy now and pay later. e.g. Mortgages

• Producers: Allows them to borrow money from financial institutions to enable them to grow without having to save all necessary money

• government: Allows them to spend money when tax revenue hasn’t been collected or they wish to spend more than they intend to raise in taxes.

what is liquidity provision

liquidity refers to how easy it is to turn an asset into cash

what is risk management in the financial sector

it is when financial institutions allow both individuals and businesses to pool their risks from exposure to financial markets.

e.g. a finance manager will take savings from a range of customers and invest the money in a range of different companies, so that if one does less well, the savers do not loser all their money.

how do interest rates affect the level of savings? (graph)

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

define saving(s)

the part of a persons income which is not spent on consumption.

define borrowing

to receive money from another party with the agreement that the money will be repaid

how do interest rates affect the level of borrowing? (graph)

higher interest rates increases the cost of borrowing so therefore firms and individuals tend to borrow less.

how do interest rates affect the level of investment? (graph)

the level of investment is inversely related to the rate of interest. if interest rates go up then investment will go down.