4.1 the structure of financial markets and financial assets

figure out M3 and M4 and what broad money includes

Characteristics of money

Durable and portable, holds value over time, hard to counterfeit, acceptable when making transactions, divisible, limited supply (scarce), uniformity

4 functions of money

Medium of exchange

Store of value

Unit of account

Standard of deferred payment

Significance of medium of exchange as a function of money

Money acts as an intermediary in the exchange of goods and services. It eliminates the inefficiencies of a barter system where a double coincidences of wants is required.

Significance of unit of account as a function of money

Money provides a common measure of the value of goods and services. Allowing for price comparisons, assessing costs , simplifying economic decision making and planning

Significance of store of value as a function of money

Allows wealth and value to be stored over time without a significant loss of value, assuming a stable currency and low inflation. This is because money is durable unlike perishable goods or non liquid assets

Significance of standard of deferred payment as a function of money

Facilitates agreements of future payments such as loans or contracts. Method to value a debt thereby allowing goods to be acquired now and paid for in the future.

Which characteristics of money are relevant to which functions

Store of value - durable, holds value over time, limited supply

Unit of account - durable, divisible, holds value over time, uniformity

Standard of deferred payment - durable, holds value over time

Medium of exchange - accepted, divisible,

Narrow money includes

Notes, coins and sight deposits

M0 and M1

Narrow money layman definition

Money that can be accessed immediately

What is included in broad money

All of narrow money, time deposits and balances at other financial institutions eg T bills

M0 to M4

The money supply

The stock of money in an economy at a point in time

M0

notes, coins and central bank reserves

M1

M0 + sight deposits

M2

M1 + time deposits

What percentage of uk’s money supply is cash (2020)

4%

Liquidity

How quickly an investment cam be sold without negatively impacting its price/loss of value

What is the most liquid asset

Cash

Describe a bank deposit in terms of assets and liabilities for the different stakeholders

Asset to the account holder/customer

Liability to the bank

Why was cash a liability to the BoE before 1931

If asked by note owners they would have to convert banknotes into gold on demand

Monetarism

An economic school of thought which believes that the supply of money in an economy is the primary driver of economic growth

commodity money vs fiat money

Fiat money is money that is backed by public faith in the issuer, in contrast to commodity money that is backed by the intrtinsic value of a valuable substance eg gold

The size of money supply determines the…

Willingness of consumers to spend

what are the 3 main financial markets

money, capital and foreign exchange market

money market

Market for short term borrowing(less than 1 year) to finance for businesses and households including interbank lending

examples of short term financial assets

T-bills, commercial paper and CODs

capital market

Market where securities such as shares, and bonds are issued to raise medium to long-term finance for businesses & government including the primary and secondary market.

primary market

The market where initial public offerings occur so new securities are issued

secondary market

previously issued financial instruments such as stock, bonds, and

foreign exchange market

where currencies are traded and exchange rates are determined.

6 key roles of financial markets

1. To facilitate savings by businesses and households - offering a secure place to store money and earn intrest

2. To lend money as an intermediary to businesses and individuals

3. to allocate funds to their most productive use - allocate capital to where the risk adjusted rate of return is the highest

4. To facilitate the final exchange of goods and services - eg contactless payment, bank transfer

5. To provide forwards markets - insure against price volatility for commodities and currencies

6. To provide a market for equities - raise fresh equity for businesses to invest and expand

Explain the relationship between Money supply and economic growth

An increase in money supply can stimulate economic growth by lowering interest rates, encouraging borrowing and spending; however, excessive money supply may lead to inflation.

debt vs equity

two types of financing available to a company when it needs to raise capital: equity financing and debt financing.

debt - borrow money which must be repayed with intrest, but maintain full ownership

equity - selling a stake of the company, does not need to be paid back

equation relating coupon, yeild and bond price

yeild = coupon/bond price

coupon is fixed

bond price changes causes an inverse change in yeald

what is the coupon of the bond

fixed intrest rate, expressed as a percentage of the bonds face value that the issuer promises to pay

what is the yeild of a bond

the anual return an investor can expect to recieve from a bond

why is the yeild of a bond different to the coupon

the yeild reflects the total return including the the capital gain or loss from changes in bond price

methods firms can use to raise finance

debt financing - borrowing from a bank or corporate bonds/bills

equity financing - isuing shares

why is there an inverse relationship between market intrest rates and bond prices

when intrest rates rise → new bonds are issued with a higher coupon rate → older bonds with lower coupons become less atractive while the new bonds become more attractive → price of the older bonds falls until their yield increases → until the yeilds match

Spot market

Where currencies or commodities are traded for immediate delivery (opposite of futures market)