financial markets and monotary policy

• the financial sector includes commercial and investment banks
• the role of the financial sector is to help people save, provide loans, and allow equities and bonds to be trades on capitol markets
• assets are things that individuals and institutions own
• liabilities are things that individuals and institutions owe
• money is a medium of exchange of payments and a store of wealth
• commodity money is the earliest form of money, it had inherent value
• representative money is money that has no inherent value but rather represents something of agreed woth
• money supply is the stock of financial assets that function as money
• narrow money is the portion of the stock of money that is in liquid or cash deposits
• broad money includes all liquid assets as well as some non liquid assets
• liquidity is a measure of how easily an assets can be converted into cash without loss of value
• share are an undated financial assent sold by a firm to raise capitol. unlike a loan a share signals that its holder owns part of the enterprise
• a bond is a long term form of borrowing that usually has a maturity date of when it must be paid
• equity is an asset that someone owns
• debt is a financial liability that someone owea
• bills are short term investments issues by a central bank that has a very low chance of loosing value
• money markets provide short term finance such as borrowing and lending. the government borrows short term finance by issuing bills that are re-payable in 91 days
• capitol markets provide long term finance through the trading of bonds and shares
• a coupon is the guaranteed fixed annual interest paid by the issuer of a bond to its owner
• there is an inverse relationship between bond prices and interest rares
• because bonds pay a fixed rates of interest when interest rates fall bonds become more attractive as they are more lucrative than other investments
• if interest rates rise then investors will no longer prefer the lower fixed rates found in bonds causing the demand for and price of bonds to fall
• bond yield = ( annual coupon payment / guilts current market price ) x 100
• commercial banks accept savings, lend to individuals and firms, facilitate payments, move funds from lenders to borrowers
• investment banks don't take deposits from consumers. rather, they arrange bond and share issues, buy and sell securities
• pension funds are long term investors that invest money sensibly
• insurance firms cover unexpected events
• hedge funds diversify investments of large sums of money
• private equity firms invest in businesses
• hedge funds and private equity firms can be described as part of shadow banking as they are poorly regulated
• loanable funds theory states that interest rates are determined by savers and borrowers
• loanable funds describes the total amount of money available for borrowing. loanable funds suggests that the interest rate is set by the supply of loanable funds
• the higher the interest rate the higher the supply of loanable funds is likely to be
• under liquidity preference theory demand for money depends on wether people prefer to store their wealth in liquid or iliquid forms
• storing wealth in liquid form is more stable
• storing wealth in an illiquid form (e.g. in bonds) is unstable as there is a potential to either loose or gain value
• under the liquidity preference theory when there are high interest rates the demand for money is low as people will opt to store their money in illiquid forms
• systemic risk is the potential for the entire banking system to fail due to interconnectivity between banks causing a singular issue to multiply
• moral hazard occurs because of the profit incentives associated with lending to risky borrowers and from the existence of a lender of last resort
• speculation may force the price of an asset falsely high as investors buy shares only because others are doing so. when these investors pull out this is described as the "market bubble bursting" in which case those who are unable to sell their assets on time are left with valueless stock