Financial sector

• Financial market?


  any set of arrangements that allow buyers and sellers to come into contact for the purpose of trading financial services and assets (those that are monetary in nature)
• Key roles for financial markets?


  providing services for households, firms and governments eg banking, insurance, investment, lending/borrowing

  speculation- allowing participants to make a capital gainby 'betting' on the way in the price of a financial asset will change- form of gambling
• Role of financial markets?


  Saving

  Lending

  Facilitating the exchange of goods and services (trade)

  Forward payments- buying something to recieve it in the future, such as when prices are volatile

  facilitsting the trade in shares

  Insurance
• financial institutions?


  Retail banks, commerical banks, investment banks, saving vehicles, speculators, insurance companies
• Financial markets?


  Money market, capital market, forex (foreign exchange), commodity market (agricultural and metals), insurance markets
• Money market?


  Provide short term borrowing and lending up to one year.

  The UK government issues treasury bills (repayable after 91 days), firms issue bills of exchange for goods
• forex market?


  Trading of currency.

  Spot markets allow currency to be traded in the present whilst forward markets arrange the exchange of currencies in the future for a price that is fixed in the current- speculative
• Speculation?


  the act of trading in an asset or conducting a financial transaction that has a significant risk of losing most or all of the initial outlay with the expectation of a substantial gain
• Asset bubble?


  In the financial context, refers to a situation where the price of an asset exceeds its intrinsic value by a large margin
• Financial asset?


  A tangible asset whose value is derived from a contractual claim, such as bank deposits, bonds and shares
• Intrinsic value?


  the actual/ true value of a company or an asset in terms of bot tangible and intangible factors
• Asset bubble process?


  During a bubble, prices for a financial asset are highly inflated, bearing little relation to the intrinsic value of the asset.

  The price is well above historical norms or intrinsic value, or both

  Causes a loss of confidence
• bubble burst?


  Refers to the fall in price of the asset over a short time period

  eg increase in interest rate burst US housing bubble, realsiation that internet companies werent profitable caused DotCom

  Large increase in supply and decrease in demand (demand, supply diagram)
• Market failure?


  a misallocation of resources
• Market failure of properties?


  eg In Spain, too main resources were allocated to the property market

  property prices rose, demand rose in expectation of higher prices, firms borrow to build more- bubble bursts, demand falls and property prcies fall, property firms experience negative equity, banks forclose on mortgage repayments, diffocult to sell properties so are lesft empty
• Macroeconomic effects of market failure?


  Falling asset prices have negative wealth effect, so reduces AD. Negative mulitplier, higher unemployment, negative growth, recession
• Hysteresis due to market failure?

  short term demand-side changes have a long term impact o supply. During a long recession or sshort term demand-side changes have a long term impact o supply. During a long recession or structural unemployment, people give up searing for a job and withdraw from the labour force
• Financial and economics crisis 2005-13?


  The 2008/9 global recession was due to an increase in defaults of sub prime mortgages in US as many of these loans had been sold as part of CDOs

  Banks lost a lot of their wealth and refused to lend to each other

  Reduced the supply of loans known as the Credit Crunch

  The BofE acted as a lender of last resort
• Asymmetric information market failure?


  financial institutions usually have more knowledge about the market and products than their customers. Such as PPI being missold
• Moral hazard market failure?


  refers to a situation where people will behave differently as they know another party bears the risk of their actions eg banks take more risks as the government will bail them out
• market rigging market failure?


  collusive behaviour where groups or individuals fix prices and exchange information for personal gain. eg LIBOR
• Financial regulation?


  the process of supervising the actions and businesses of financial service providers to promote consumer confidence and protect people from dishonest, incompetent or financially unstable providers
• purpose of financial regulation?


  maintain market confidence, create the conditions for financial stability, ensure consumer protection and policing financial crime
• macroprudential regulation?


  the rules that aim to alleviate risk to the financial system as a whole
• microprudential regularion?


  oversight of financial institutions, on an individual basis, to ensure their balance sheets are robust to shocks
• systematic risk?


  the risk of collapse of an entire financial system or financial market
• bubble characteristics?

  suspension of disbelief during the 'bubble phase', failure to recognise that speculative exercise is raising the value- herd mentality, most bubbles are identified afterwards, followed by a speculative crash causing a decrease in demand