4.2.4- Financial Markets and Monetary Policy
The Structure of Financial Markets and Financial Assets
THE FUNCTIONS OF MONEY
• A Medium of Exchange- The majority of G's and S's are traded or exchanged via the intermediary of
money
• A Store of Value- The majority of people store some of their wealth in the form of money, rather than other
assets, such as stocks, shares or property
• A Method of Deferred Payment- Allows people to delay paying for goods or settling a debt, even though
G's or S's are being paid immediately- money payment specified in future
• Unit of Account- Prices of goods are quoted in terms of money, which allows us to compare the relative
values of goods even if a consumer has no intention of buying that good
CHARACTERISTICS OF MONEY
1) Acceptable
2) Portable
3) Durable
4) Divisible
5) Limited in Supply
6) Difficult to Forge
MONEY SUPPLY
• The stock of money in the economy at a particular point in time, including coins, notes and bank deposits
• Liquidity- The ease with which an asset can be converted into cash without loss of value- cash is most
liquid of all assets
NARROW MONEY- The part of the money supply made of cash and liquid bank and building society deposits
(M0)
BROAD MONEY- The part of the money supply made of cash and liquid bank and building deposits but also
some less liquid assets (M4)
MAIN FINANCIAL MARKETS
• Money Market
◦ An umbrella that covers several markets, including the markets for Treasury bills and commercial bills
◦ Assets bought and sold are short term, with maturities ranging from day to a year and are usually
highly liquid assets
◦ Provides a mechanism for banks to arrange their assets in terms of their liquidity and profitability-
enables commercial banks to perform a financial intermediary, linking savers and borrowers
• Capital Market
◦ Where securities such as shares and bonds are issued to raise medium to long term financing
(Primary) and where they are sold on the secondhand part of the market (Secondary), e.g. London
Stock Exchanage
◦ Allows organisations to raise funds necessary to finance LT growth and governments to finance
budget deficits, e.g. issuing gilts on bond market
, • Foreign Exchange Markets
◦ Global decentralised markets for the trading of currencies, mainly large international commercial
banks are involved
◦ Collectively largest markets in global economy
◦ Allows exporters and importers to convert funds to trade from one currency to another
◦ Over last 60 years market has become increasingly important in facilitating growth of international
trade and inter-regional capital movements
◦ Spot=Immediate transactions, Forward=Transactions occurring at specified time in future
DEBT AND EQUITY
• Equity- involves giving the provider of funds an ownership stake in the enterprise and a share of future
profits
• Debt- involves borrowing money that has to be paid back with interest
◦ Interest is a fixed cost for the business which has to be paid before profits are calculated and any
dividends are paid for shareholders
◦ Also includes funds that firms borrow directly from banks and other financial institutions such as
loans and overdrafts
◦ Both governments and large corporations issue bonds to raise finance, contributing to its
government debt
‣ The issuer of the bond is the debtor and the holder of the bond is the creditor
• Bonds have a fixed maturity date
BOND PRICES, MARKET INTEREST RATES AND YIELDS
Shares- Undated financial assets, sold initially by a company to raise financial capital- shares sold by public
companies are marketable on the London Stock Exchange but private shares are not. Signifies that the
holder owns part of the enterprise
Corporate Bonds- Debt security issued by a company and sold as new issues to people who lend long-term
to the company
Government Bonds- Debt security, known as gilts, issued by the government and sold as new issues to
people who lend long-term to the government- can be resold secondhand
Coupon- The guaranteed fixed annual payment, often divided into 2 6 month payments, paid by issuer to
owner of bond
Maturity Date- The date on which the issuer of a dated security pays the face value of the security to its
owner
Yield- the annual interest payment or coupon value, expressed as a % of the market price of the bond
‣ (Coupon value/Market price) x 100
The Structure of Financial Markets and Financial Assets
THE FUNCTIONS OF MONEY
• A Medium of Exchange- The majority of G's and S's are traded or exchanged via the intermediary of
money
• A Store of Value- The majority of people store some of their wealth in the form of money, rather than other
assets, such as stocks, shares or property
• A Method of Deferred Payment- Allows people to delay paying for goods or settling a debt, even though
G's or S's are being paid immediately- money payment specified in future
• Unit of Account- Prices of goods are quoted in terms of money, which allows us to compare the relative
values of goods even if a consumer has no intention of buying that good
CHARACTERISTICS OF MONEY
1) Acceptable
2) Portable
3) Durable
4) Divisible
5) Limited in Supply
6) Difficult to Forge
MONEY SUPPLY
• The stock of money in the economy at a particular point in time, including coins, notes and bank deposits
• Liquidity- The ease with which an asset can be converted into cash without loss of value- cash is most
liquid of all assets
NARROW MONEY- The part of the money supply made of cash and liquid bank and building society deposits
(M0)
BROAD MONEY- The part of the money supply made of cash and liquid bank and building deposits but also
some less liquid assets (M4)
MAIN FINANCIAL MARKETS
• Money Market
◦ An umbrella that covers several markets, including the markets for Treasury bills and commercial bills
◦ Assets bought and sold are short term, with maturities ranging from day to a year and are usually
highly liquid assets
◦ Provides a mechanism for banks to arrange their assets in terms of their liquidity and profitability-
enables commercial banks to perform a financial intermediary, linking savers and borrowers
• Capital Market
◦ Where securities such as shares and bonds are issued to raise medium to long term financing
(Primary) and where they are sold on the secondhand part of the market (Secondary), e.g. London
Stock Exchanage
◦ Allows organisations to raise funds necessary to finance LT growth and governments to finance
budget deficits, e.g. issuing gilts on bond market
, • Foreign Exchange Markets
◦ Global decentralised markets for the trading of currencies, mainly large international commercial
banks are involved
◦ Collectively largest markets in global economy
◦ Allows exporters and importers to convert funds to trade from one currency to another
◦ Over last 60 years market has become increasingly important in facilitating growth of international
trade and inter-regional capital movements
◦ Spot=Immediate transactions, Forward=Transactions occurring at specified time in future
DEBT AND EQUITY
• Equity- involves giving the provider of funds an ownership stake in the enterprise and a share of future
profits
• Debt- involves borrowing money that has to be paid back with interest
◦ Interest is a fixed cost for the business which has to be paid before profits are calculated and any
dividends are paid for shareholders
◦ Also includes funds that firms borrow directly from banks and other financial institutions such as
loans and overdrafts
◦ Both governments and large corporations issue bonds to raise finance, contributing to its
government debt
‣ The issuer of the bond is the debtor and the holder of the bond is the creditor
• Bonds have a fixed maturity date
BOND PRICES, MARKET INTEREST RATES AND YIELDS
Shares- Undated financial assets, sold initially by a company to raise financial capital- shares sold by public
companies are marketable on the London Stock Exchange but private shares are not. Signifies that the
holder owns part of the enterprise
Corporate Bonds- Debt security issued by a company and sold as new issues to people who lend long-term
to the company
Government Bonds- Debt security, known as gilts, issued by the government and sold as new issues to
people who lend long-term to the government- can be resold secondhand
Coupon- The guaranteed fixed annual payment, often divided into 2 6 month payments, paid by issuer to
owner of bond
Maturity Date- The date on which the issuer of a dated security pays the face value of the security to its
owner
Yield- the annual interest payment or coupon value, expressed as a % of the market price of the bond
‣ (Coupon value/Market price) x 100
