Year 13 Macro

• Money


  Anything generally accepted in payment of a debt; removes the needs to barter, avoiding the double coincidence of wants
• Characteristics of money


  • Acceptable to all
  • Portable
  • Durable
  • Easily divisible
  • Not able to be counterfeited
  • Scarce in supply
• Financial Markets


  Buyers and sellers come together to trade financial assets, such as stocks, bonds, currencies, and derivatives
• Monetary Policy


  The main goal is to match buyers and sellers to efficiently allocate financial capital to its most productive uses helping to increase economic growth
• Key roles of financial markets

  • Facilitate saving by businesses/households
  • Lend to businesses/consumers
  • Allocate funds to productive uses
  • Facilitate the final exchange of goods/services
  • Provide forward markets to allow economic agents to insure against price instability and hedge against possible risks
  • Provide a market for equities, allowing business to raise new capital
  • Provide information about the prices of financial assets
• Money supply


  The total quantity of money that is available for transactions, typically categorised into different monetary aggregates based on liquidity and accessibility
• Types of money supply

  • Narrow Money (M1): Physical currency and checking deposits
  • Broad Money (M2, M3, etc.): Savings accounts, time deposits, and other near-money assets
• Liquidity


  Highly liquid assets are easy to convert to cash
• Money market


  Short-term, highly liquid debt securities including instruments like Treasury bills, commercial paper, and certificates of deposit
• Capital market


  Long-term debt and equity securities, including stocks, bonds, and real estate investments
• Foreign exchange market


  Currencies are bought and sold; facilitates international trade and investment
• Types of financial assets

  • Stocks
  • Bonds
  • Mutual funds
  • Exchange-traded funds (ETFs)
  • Derivatives
• Digital money


  A form of currency that exists solely in electronic or digital form, including digital wallets, cryptocurrencies, central bank digital currencies and pre-paid cards
• The Four Functions of Money

  • Medium of exchange
  • Unit of account
  • Store of value
  • Standard for deferred payment
• Equity


  Represents ownership in a company and pay dividends to shareholders
• Debt


  A debt instrument that pays interest to the bondholder
• Inverse relationship


  Bonds prices & yields
• Commercial banks


  Provide traditional banking services such as accepting deposits, making loans, and offering checking and savings accounts
• Investment banks


  Specialise in underwriting securities, M&A advisory, trading, research, and asset management
• Functions of a commercial bank

  • Accepting deposits
  • Providing loans
  • Payment services
  • Safekeeping of valuables
  • Currency exchange
• Money or credit creation by commercial banks

  1. Banks create credit by agreeing loans to businesses and households

  2. New money is created when a bank makes a loan and credits the borrower's account

  3. Fractional reserve system: banks create credit by using the fractional reserve system, where they are required to hold only a fraction of their deposits as cash / liquid reserves and can lend out the rest

  4. Money multiplier effect: when banks lend out a portion of the funds deposited with them, these funds are deposited in other banks, creating a chain reaction of lending and increasing the money supply

  5. Credit creation process: as banks make loans, they effectively create new money in the form of additional deposits, contributing to economic activity measured by GDP
• Assets of a commercial bank

  • Cash and Reserves
  • Loans and Advances
  • Investments
• Liabilities of a commercial bank

  • Deposits
  • Borrowings
  • Capital
• Liquidity v Profitability


  Striking the right balance between liquidity and profitability can be challenging. While maintaining high liquidity ensures safety, it may reduce potential profits. Banks must decide how much liquidity to hold.
• Profitability v Security


  Pursuing higher profitability often involves taking on more risk, which can jeopardise the security of customer deposits. Balancing these objectives is crucial for long-term sustainability.
• Limitations on money creation

  • Market forces
  • Risks of lending including default risk
  • Regulatory policies such as minimum capital reserve requirements
  • Monetary policy - level of policy interest rates set by the Bank of England
• Base rate


  The main interest rate set by a nation's central bank; the rate of interest charged to commercial banks if they must borrow from the central bank when short of liquidity
• Market interest rates


  Rates for savings, bank overdrafts, mortgages, credit cards, pay day loans etc.
• Main roles of a central bank

  • Monetary policy
  • Financial stability
  • Managing the currency
  • Lender of last resort
  • Financial supervision
  • Research
• Financial regulation bodies in the UK

  • Prudential Regulation Authority (PRA)
  • Financial Conduct Authority (FCA)
  • Financial Policy Committee (FPC)
• PRA


  Responsible for prudential supervision, assessing and ensuring the financial soundness of financial institutions to prevent financial instability
• FCA


  Responsible for regulating financial institutions, setting regulatory rules and standards, conducting prudential supervision, ensuring fair and transparent financial products and services, and supervising financial markets
• FPC


  Identifies systemic risks, sets policy tools to address these risks, and conducts stress tests to assess the resilience of the financial system
• Why regulation is important

  • Preventing systemic risk
  • Protecting consumers
  • Ensuring fair competition
  • Promoting financial stability
• Why commercial banks can fail
• Financial regulation


  • Imposes capital requirements for banks, leverage ratios, liquidity requirements, and more
  • Conducts stress tests to assess how well the financial system and individual institutions can withstand adverse economic conditions and shocks
• Systemic risk


  The risk of a major financial crisis by requiring financial institutions to maintain adequate capital and liquidity, and by limiting risky activities
• Protecting consumers


  Financial regulation protects consumers from fraud, predatory lending, and other harmful practices
• Ensuring fair competition


  Financial regulation promotes fair competition in the financial industry by preventing anticompetitive behaviour and unfair pricing practices
• Promoting financial stability


  Financial regulation helps to prevent the kind of market instability that can lead to economic downturns and recessions