The structure of financial markets and financial assets
The characteristics and functions of money
1. A medium of exchange
a. Before money, transactions were made through barter
b. This was not sustainable because the goods and services exchanged did not always
have the same value
c. People wanted specific goods for their items which most people couldn’t offer
2. A measure of value
a. Money provides a means to measure the relative values of different goods and
services
b. Money also puts a value on labour
3. A store of value
a. Money has to hold its value to be used for payment
b. It can be kept a long time without expiring
c. However, the quantity of goods and services that can be bought with money
fluctuates slightly with the forces of supply and demand
4. A method of deferred payment
a. Money can allow for debts to be created
b. People can therefore pay for things without having money in the present, and can
pay for it later
c. This relies on money storing its value
Definitions of the money supply and the distinction between narrow and broad money
The money supply is the stock of currency and liquid assets in an economy. It includes cash
and money held in savings accounts
o Narrow money is physical currency (notes and coins) as well as deposits and liquid
assets in the central bank
o Broad money includes the entire money supply. Cash could be restricted accounts
which makes it hard to calculate the money supply
It includes liquid and less liquid assets
The difference between the money market, the capital market and the foreign exchange market
In the money market, liquid assets are traded. It is used to borrow and lend money in the
short term
The capital market is where equity and debt instruments are bought and sold. These can
then be put to long-term productive use by firms and governments
The foreign exchange market is a market where currencies are traded, mainly by
international banks
o It determines what the relative value of different currencies will be
The role of financial markets in the wider economy
Financial liquid assets are exchanged in a financial market
For example the stock market and the bond market are two examples of financial markets
To facilitate saving
o 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
, o The transfer of funds between agents is aided by financial markets. The funds can be
used for investment or consumption.
To facilitate the exchange of goods and services
o 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
o 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.
o In commodity markets, investors trade primary products, such as wheat, gold and
oil. Future 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.
o A forward market is an informal financial market where these contracts for future
delivery are made.
To provide a market for equities
o Equity markets involve the trade of shares. It is also called a stock market. Equity
markets provide access to capital for firms, and allow investors to own part of a
market.
o 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
The difference between debt and equity
Debt is money which has been borrowed from a lender, which is usually a bank. There is
little flexibility, and the loan is later repaid with interest.
Equity is a stock or security which represents interest in owning e.g. a firm, a car or a house.
It is when there is no outstanding debt, such as when a loan for a car or a mortgage has been
fully paid off.
The owner’s equity is then the car or the house, which can be sold for cash.
Why there is an inverse relationship between market interest rates and bond prices
There is an inverse relationship between market interest rates and bond prices, when a
bond is bought, money is lent to the issuer
The issuer agrees to pay the value of the bond when it matures, in addition to periodic
interest payments
The rate of interest is fixed when the bond is issued
o New bonds have rates close to the market interest rate
o If the market interest rate falls, for example, the bond would be worth more, since it
carries a higher interest rate than current market conditions
o Similarly, the bond is worth less if the rate increases
o This is because the bond has a lower interest rate than the current market
Firms can raise finance by issuing shares, issuing corporate bonds and borrowing from a
bank.
Raising finance through shares is relatively cheap for firms
Although firms are legally obliged to pay their shareholders dividends, a proportion of their
profits as a reward for investing in them, they only pay dividends when there are
distributable profits and it is voted for by shareholders.
o Borrowing could involve paying back loans with high interest rates, which could be
expensive
The characteristics and functions of money
1. A medium of exchange
a. Before money, transactions were made through barter
b. This was not sustainable because the goods and services exchanged did not always
have the same value
c. People wanted specific goods for their items which most people couldn’t offer
2. A measure of value
a. Money provides a means to measure the relative values of different goods and
services
b. Money also puts a value on labour
3. A store of value
a. Money has to hold its value to be used for payment
b. It can be kept a long time without expiring
c. However, the quantity of goods and services that can be bought with money
fluctuates slightly with the forces of supply and demand
4. A method of deferred payment
a. Money can allow for debts to be created
b. People can therefore pay for things without having money in the present, and can
pay for it later
c. This relies on money storing its value
Definitions of the money supply and the distinction between narrow and broad money
The money supply is the stock of currency and liquid assets in an economy. It includes cash
and money held in savings accounts
o Narrow money is physical currency (notes and coins) as well as deposits and liquid
assets in the central bank
o Broad money includes the entire money supply. Cash could be restricted accounts
which makes it hard to calculate the money supply
It includes liquid and less liquid assets
The difference between the money market, the capital market and the foreign exchange market
In the money market, liquid assets are traded. It is used to borrow and lend money in the
short term
The capital market is where equity and debt instruments are bought and sold. These can
then be put to long-term productive use by firms and governments
The foreign exchange market is a market where currencies are traded, mainly by
international banks
o It determines what the relative value of different currencies will be
The role of financial markets in the wider economy
Financial liquid assets are exchanged in a financial market
For example the stock market and the bond market are two examples of financial markets
To facilitate saving
o 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
, o The transfer of funds between agents is aided by financial markets. The funds can be
used for investment or consumption.
To facilitate the exchange of goods and services
o 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
o 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.
o In commodity markets, investors trade primary products, such as wheat, gold and
oil. Future 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.
o A forward market is an informal financial market where these contracts for future
delivery are made.
To provide a market for equities
o Equity markets involve the trade of shares. It is also called a stock market. Equity
markets provide access to capital for firms, and allow investors to own part of a
market.
o 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
The difference between debt and equity
Debt is money which has been borrowed from a lender, which is usually a bank. There is
little flexibility, and the loan is later repaid with interest.
Equity is a stock or security which represents interest in owning e.g. a firm, a car or a house.
It is when there is no outstanding debt, such as when a loan for a car or a mortgage has been
fully paid off.
The owner’s equity is then the car or the house, which can be sold for cash.
Why there is an inverse relationship between market interest rates and bond prices
There is an inverse relationship between market interest rates and bond prices, when a
bond is bought, money is lent to the issuer
The issuer agrees to pay the value of the bond when it matures, in addition to periodic
interest payments
The rate of interest is fixed when the bond is issued
o New bonds have rates close to the market interest rate
o If the market interest rate falls, for example, the bond would be worth more, since it
carries a higher interest rate than current market conditions
o Similarly, the bond is worth less if the rate increases
o This is because the bond has a lower interest rate than the current market
Firms can raise finance by issuing shares, issuing corporate bonds and borrowing from a
bank.
Raising finance through shares is relatively cheap for firms
Although firms are legally obliged to pay their shareholders dividends, a proportion of their
profits as a reward for investing in them, they only pay dividends when there are
distributable profits and it is voted for by shareholders.
o Borrowing could involve paying back loans with high interest rates, which could be
expensive
