4.5 Risk and the financial sector

• difference between risk and uncertainty

  risk is the probability of damage, whereas uncertainty refers to a situation which may or may not happen
• when do banks face risk

  when they loan money to consumers. since there is a chance that they may not receive that money back
• economic shocks


  unforeseen events that could have a devasting effect on the economy
• biggest economic shock in the 2000's

  the global financial crisis of 2008
• what is a futures contract

  when a price of an asset is agreed upon today, but delivery is in the future
• insurance purpose


  to reduce the risk of decisions
• role of financial markets

  provide a place for investors and consumers to store their funds
• how can financial markets benefit firms

  these markets can provide firms with funds for them to invest and expand production
• what are equity markets

  where transfer of shares take place
• dividends


  shares of company profits that investors receive
• what is a lender of last resort

  when the central bank has the capability of lending to banks in times of major crises or when a bank is about to go into insolvency
• which 2 regulators watch over the UK banking sector

  The financial conduct authority and the prudential regulation authority
• role of the FCA

  ensure banks are protecting consumer interests
• role of the PRA

  promotes the stability of banks
• how was the 2008 recession caused

  inflated asset prices and too much risk taking by banks, as they gave loans to consumers with poor credit histories, who therefore then defaulted on their loans
• who went bankrupt in 2008

  the Lehman brothers
• how low did interest rates reach in 2008

  as low as 0.5%
• how have banks changed since the crisis

  become more risk averse, enforcing more checks on people applying for loans
• define moral hazard


  when banks purposely give out risky loans, because they know they are too big to fail, meaning the government will bail them out
• define systematic risk


  risk to the economy or financial market as a whole
• when does a market bubble occur

  when the price of an asset is expected to rise significantly