Financial Markets

Financial Markets

1. Structure of financial markets

   • Characteristics of money
     • A medium of exchange. People use to exchange goods and services but they were not always the same value. It could only take place if there was a double coincidence of wants (both parties want what the other has to offer). Using money eliminates this problem
     • A measure of value: Money provides a means to measure the relative values of different goods and services. E.g. a piece of jewellery might be considered more valubale than a table bcause of its relative price, measured by money. Money also puts a value on labour
     • A store of value: Money has to hold its value to be used for payment. It can be kept for a long time without expriing. However, the quantity of goods and services that can be bought with money fluctuates slightly with the forces of supply and demand.
     • A method of deferred payment: Money can allow for debts to be created. People can therfore pay for things without having the money in the present and can pay for it later. This relies on money storring its value.
     • Definitions
       • Money Supply- the stock of currency and liquid assets in an economy. It includes cash and money held in savings accounts.
       • Narrow money is physical currency (notes and coins) as well as deposits and liquid assets
       • Broad money includes the entire money supply. Cash could be in restricted accounts, which makes it hard to calculate the money supply. It includes liquid and less liquid assets.
   • Differences in markets
     • Money market - liquid assets are traded. It is used to borrow and lend money in the short term.
     • Capital market - where equity and debt instruments are bought and sold. These can be put to long-term productive use by firms and governments.
     • FX market - a market where currencies are traded, mainly by international banks. It determines what the relative value of different currencies will be
   • Role of financial markets
     • To facilitate saving - financial markets provide somewhere for consumers and firms to store their funds. Savings are rewarded with interest payments from the bank
     • To lend to businesses and individuals - The transfer of funds between agents is aided by financial markets. The funds can be used for investment or consumptiion
     • To facilitate the exchange of goods and services - the transfer of real economic resources is facilitated in a financial market. Financial markets can make it easier to exchange goods and services from the physical market, by providing a way that buyers and sellers can interact and transfer funds.
     • To provide forward markets in currencies and commodities - The currency market is another kind of financial market. They are used to trade one currency for another currency. Currencies can have speculative attacks taken on them , which can affect the value of the exchange rate. In the commodity markets, investors trade primary products, such as wheat, gold and oil. Furture contracts are a method for investing in commodities. This involves buying or selling an asset with an agreed price in the present, but a delivery and payment in the future. A forward market is an informal financial market where these contracts for future delivery is made.
     • To provide market for equities - Equity markets involve the trade of shares, known as the stock market. Equity markets provide access to capital for firms, and allow investors to own part of a market. Returns on the investment, usually in the form of dividends, are based on future performance. A dividend is a share of the firm's profits.

2. Commercial and Investment banks

   • A commercial bank manages deposits, cheques and saving accounts for individuals and firms. They can make loans using money saved with them.
     • Main functions
       • Accept deposits from the public, usually in the form of savings. Those on low incomes might save a part of their income for security, whilst films see saving as convenient. Banks can meet the different needs of their depositors by providing different accounts. Depositors could use Demand Deposits, which allow deposits to be made or withdrawn immediately. Fixed deposits store money for a long time. They have higher rates of interest, since banks can use these deposits knowing they will not be withdrawn. Saving
   • Investment banks facilitate the trade of stocks, bonds and other forms of investment. Government regulation is weaker in the investment bank industry , and their combined with their business model gives them a higher risk tolerance.