Key Roles for Financial Markets I A Level and IB Economics

Summary

This video script delves into the pivotal roles of financial markets, explaining their function as platforms for trading financial instruments like equities, bonds, and commodities. It outlines three main markets: the money market for short-term finance, the capital market for medium to long-term funding through securities, and the foreign exchange market for currency trading. The script also highlights the UK's financial service sector's economic impact, emphasizing its contribution to GDP, job creation, and tax revenue, while underscoring the importance of efficient financial markets in savings, borrowing, capital allocation, facilitating transactions, providing forward markets, and equity raising.

Takeaways

• 💼 Financial markets are exchanges or platforms where financial instruments like equities, bonds, currencies, and commodities are traded globally.
• 🏦 The money market is for short-term loan finance involving businesses and households, including the interbank market where banks lend to each other.
• 📈 The capital market is where securities like shares and bonds are issued to raise medium to long-term finance, such as companies issuing new shares or governments issuing bonds.
• 🌐 The foreign exchange market is where currencies are traded, and it's influenced by various factors, including political events like Brexit affecting the value of currencies like the pound sterling.
• 💷 The UK financial service sector significantly contributes to the economy, with over 130 billion pounds to UK GDP, making it the seventh biggest in the OECD relative to GDP.
• 🏙️ London is a major hub for financial services, generating nearly half of the sector's output, and is important for trade, with the majority of financial service exports going to the European Union.
• 💼 The financial service sector provides around a million jobs in the UK, which is about 3% of all employment, highlighting its importance for employment.
• 💰 Financial markets have six key roles: providing a means to save, a platform to borrow, allocating funds for productive uses, facilitating trade, providing forward markets for hedging, and offering a market for equities and capital raising.
• 🏦 Efficient financial markets are crucial for the economy as they help in the optimal allocation of capital to where the risk-adjusted return on investment is the highest.
• 🔄 Forward markets allow corporations to hedge against future price uncertainty and ensure against price volatility, which is vital for risk management.
• 🌟 The financial markets' roles are universal and apply to both high-income advanced countries and emerging nations, emphasizing their global significance.

Q & A

What is a financial market?

A financial market is an exchange or platform that facilitates the trading of financial instruments, such as equities, bonds, currencies, and commodities.

What are the three main types of financial markets mentioned in the script?

The three main types of financial markets are the money market, the capital market, and the foreign exchange market.

What is the purpose of the money market?

The money market is for short-term loan finance for businesses and households who need to borrow money, and includes the interbank market where commercial banks lend to each other.

What does the London Interbank Offered Rate (LIBOR) represent?

The LIBOR represents the rate at which commercial banks are prepared to lend to each other when one or more of them is short of liquidity.

What is the role of the capital market in financial markets?

The capital market is where securities such as shares (equities) and bonds are issued to raise medium to long-term finance.

How does the script describe the foreign exchange market?

The foreign exchange market is where currencies are traded, and it is influenced by various economic factors and events, such as the Brexit referendum affecting the sterling exchange rate.

What is the significance of the financial service sector to the UK economy?

The financial service sector contributes significantly to the UK GDP, with over 130 billion pounds, and is a major source of employment and tax revenue.

What is the role of financial markets in providing a means for people to save?

Financial markets provide a system where people can store money efficiently, maintain its value, and earn interest, which is both easy to operate and trusted.

How do financial markets facilitate borrowing for businesses and individuals?

Financial markets act as intermediaries between savers and borrowers, repackaging cash flows and allowing for borrowing through instruments like mortgages and business loans.

What is the role of financial markets in allocating funds for productive uses?

Efficient financial markets allocate funds to where the risk-adjusted rate of return on investment is highest, thus directing capital to its most productive uses.

How do financial markets assist in the transactional function of exchanging goods and services?

Financial markets facilitate the final exchange of goods and services through methods like contactless payment cards, enabling easy transactions and access to trade credits and foreign exchange.

What is the purpose of forward markets in financial markets?

Forward markets allow agents, particularly corporations, to hedge against future price uncertainty and volatility by buying currency or other assets ahead of time.

How do capital markets contribute to business expansion and investment?

Capital markets provide a platform for businesses to raise equity and debt to fund their investment and expansion, supporting growth and development.

Outlines

00:00

💼 Introduction to Financial Markets

This paragraph introduces the concept of financial markets as exchanges or platforms for trading financial instruments, such as equities, bonds, currencies, and commodities. It explains the three main types of financial markets: the money market for short-term loans, the capital market for issuing securities like shares and bonds, and the foreign exchange market for currency trading. The paragraph also touches on the significance of the UK financial service sector to the economy, highlighting its contribution to GDP, the importance of London, and the impact of Brexit on the pound sterling.

05:01

🏦 Roles of Financial Markets in the Economy

The second paragraph delves into the six key roles that financial markets play in any economy, whether developed or emerging. It discusses the importance of financial markets in providing a means for people to save, facilitating borrowing for businesses and individuals, efficiently allocating funds for productive uses, enabling the exchange of goods and services, offering forward markets for hedging against price volatility, and providing a platform for businesses to raise equity and debt. The paragraph also emphasizes the substantial trade surplus in financial services that the UK enjoys, particularly with the European Union, and the tax contributions of the financial sector.

Keywords

💡Financial Markets

Financial markets are exchanges or platforms that facilitate the trading of financial instruments. They are central to the economy as they provide a mechanism for the exchange of capital between savers and borrowers. In the video's context, financial markets are categorized into the money market, capital market, and foreign exchange market, each serving different financial needs and playing a critical role in the allocation of resources and the functioning of the economy.

💡Equities

Equities, also known as stocks or shares, represent ownership interests in a company. They are a type of financial instrument traded on financial markets. The video script mentions equities as one of the instruments that can be issued by companies on the capital market to raise medium to long-term finance, illustrating their importance in the capital allocation process.

💡Bonds

Bonds are debt securities issued by governments or corporations to raise funds. They represent a loan made by an investor to the bond issuer, with the promise of repayment with interest over a specified period. The script refers to bonds as instruments that can be issued on the capital market to finance government spending or corporate projects.

💡Currency Trading

Currency trading involves the buying and selling of currencies in the foreign exchange market. It is a significant aspect of financial markets, as it allows for the conversion of one currency to another and is essential for international trade and investment. The video discusses the foreign exchange market and its role in trading currencies such as dollars, yen, yuan, and sterling.

💡Money Market

The money market is a segment of the financial market that deals with short-term debt instruments and is typically used by businesses and households for short-term borrowing needs. In the video, the money market is highlighted as the market involving commercial banks and the interbank market, where banks lend to each other at the interbank interest rate.

💡Capital Market

The capital market is a financial market where longer-term securities such as equities and bonds are issued to raise medium to long-term funds. It is essential for companies looking to expand and for governments needing to finance their spending. The script explains how the capital market operates and its significance in the economy.

💡Foreign Exchange Market

The foreign exchange market, also known as Forex, is the global marketplace for trading currencies. It is the largest and most liquid financial market in the world. The video script discusses the foreign exchange market's role in trading various currencies and its impact on the economy, as illustrated by the sterling exchange rate index.

💡Financial Instruments

Financial instruments are tools used in financial markets to raise funds, invest, or trade. They include a wide range of assets such as equities, bonds, currencies, and commodities. The video script mentions financial instruments as the commodities traded in financial markets, emphasizing their importance in global trade and investment.

💡Interbank Market

The interbank market is a part of the money market where banks lend and borrow from each other to manage their liquidity. It is crucial for maintaining the stability of the financial system. The video script explains the interbank market by discussing how commercial banks provide liquidity to each other at the interbank interest rate.

💡Financial Services Sector

The financial services sector encompasses a range of industries including banking, finance, trading of currencies and derivatives, and insurance. It is significant for the economy, contributing to GDP and employment. The video script provides statistics on the UK's financial services sector, highlighting its contribution to the national output and its importance in trade and tax revenue.

💡Trade Surplus

A trade surplus occurs when a country's exports of goods and services exceed its imports. In the context of the video, the UK's financial services sector had a trade surplus, indicating that it exported more services than it imported. The script discusses the financial services trade surplus and its importance to the UK economy.

Highlights

Financial markets are exchanges or platforms for trading financial instruments like equities, bonds, currencies, and commodities.

There are three main types of financial markets: money market, capital market, and foreign exchange market.

The money market involves short-term loans for businesses and households and includes the interbank market.

The capital market is for issuing securities like shares and bonds to raise medium to long-term finance.

The foreign exchange market is where currencies are traded, impacting the value of currencies like the British pound.

The UK financial services sector contributes significantly to GDP, with nearly half of the output generated in London.

Financial markets have six key roles, including providing a means for saving, borrowing, allocating funds, facilitating transactions, offering forward markets, and raising equity.

Financial markets help savers store money efficiently, hold its value, and earn interest.

Markets provide a platform for businesses and individuals to borrow money, such as for mortgages or business expansion.

Efficient financial markets allocate capital to where the risk-adjusted return on investment is highest.

Financial markets facilitate the final exchange of goods and services, making trade easier for businesses.

Forward markets allow corporations to hedge against future price uncertainty and volatility.

The capital market enables businesses to raise equity and debt to fund investment and expansion.

The UK financial services sector is the seventh biggest in the OECD, measured by its significance to GDP.

There are over a million financial service jobs in the UK, accounting for 3% of all employment.

Exports of financial services from the UK were worth over £60 billion in 2017, with a trade surplus of over £800 million.

The UK's financial service sector contributed nearly £30 billion in tax revenue in 2018.

The UK's trade relationship with the EU, particularly regarding passporting rights in banking, will be a major decision.

Transcripts

welcome to a short video looking at some

of the key roles of financial markets

financial markets is now an important

part available syllabus this will take

you through some of the key functions of

financial markets

a financial market is any exchange any

platform

that facilitates the trading of what we

call financial instruments

now that could be things like equities

stocks and shares are issued by

companies it could be bonds issued by

governments and corporations it could be

the trading of currency or foreign

exchange insurance or indeed any

globally traded primary commodities such

as oil and gas commodities in many ways

can now be treated as financial assets

traded around the world

there are three main financial markets

to get to grips with

the first is the money market

this is the market that typically

involves businesses such as commercial

banks it's the market for short-term

loan finance for businesses and

households who need to borrow money

and it also includes the inter bank

market which is where commercial banks

such as hsbc and barclays they provide

liquidity for each other by lending to

each other at the interbank interest

rate

this chart shows the three-month london

interbank offered right

it's a rate

at which the commercial banks are

prepared to lend to each other

when one one or more of them is short of

liquidity

and you can see if you look on the left

hand side

that the interest rate is fairly low it

tends to track pretty closely the base

rate of interest set by the bank of

england

the second market is the capital market

now this is a financial

market where securities such as shares

otherwise known as equities and bonds

are issued to raise medium to long-term

finance so typically for example a

company might decide to issue some fresh

equity

by issuing new shares onto the capital

market on the stock exchange the

government could go to the bond market

to issue a new bond perhaps a 10-year

loan to help finance its government

spending and here's a chart showing the

recent changes in the share price

indices for a variety of indexes

shanghai composite the footsie or share

index

standard and poor's 500

and the morgan stanley

composite index for emerging market

share prices

the third financial market to be aware

of and to understand is

the foreign exchange market and no doubt

you will have done some

of the economics of what moves

occurrences up and down foreign exchange

market

is the market where currencies

are traded dollars yen yuan menimbi and

sterling

here's a chart showing the sterling

exchange rate index this is an index

weighted according to the value of trade

that the uk does with different

countries around the world notice for

example in

2016 how the sterling index fell quite

sharply there was a significant

depreciation of sterling in the

immediate aftermath of the brexit

referendum

sterling has then traded within a fairly

narrow range from 75 to 80 on the index

over the last three or four years it

fell again last year uh perhaps because

of substantial political brexit

uncertainty but the sterling index has

increased quite a bit in the last

year or so

as we've headed into 2020.

the uk financial service sector is

significant for the economy as a whole

let's have a quick look at some of the

numbers

the industries so that includes banking

finance trading of currencies and

derivatives and insurance the financial

service sector contributed over 130

billion pounds to uk gdp last year

that's just under seven percent of

national output and london of course was

the i feel like the epicenter of

financial services nearly half of the

sector's output was generated in and

around the city of london

financial service sector in the uk was

the seventh biggest

in the oecd measured by the proportion

or the significance of the sector

relative to gdp luxembourg has the

biggest financial sector service

in that way just over a million

financial service jobs in the uk which

is about three percent of all employment

the financial service sector is also

important for trade exports of financial

services need insurance or banking

services are worth over 60 billion

pounds in 2017 imports

much less than that and that gave a

rounded down trade surplus in financial

services of over 800 million pounds a

week 44 billion in 2017.

uh the bulk of our financial service

exports went to the european union

and the super third of financial

services imports came from the eu so the

the likely shape of a trade relationship

between the uk and the opinion in

particular when it comes to

things like passporting rights in the

banking sector will be a major decision

the financial service sector contributed

nearly 30 billion pounds in tax

in 2018.

so this slide gives you a feel i hope a

feel for the significance

of financial markets to the uk economy

well what are the six key roles of

financial markets for virtually any

country developed or developing in

merging

the first is that financial markets

provide a means by which people can save

we have regular flows of income coming

in we need to be able to have a system

where we can store money quickly and

easily

a system in which money holds its value

and in which we can earn interest we

need a system which is uh both efficient

easy to operate out of which people have

trust

a second key role of financial markets

is to provide a platform by which

businesses and individuals can borrow

money be it a mortgage for a home

purchase

or a small business needing loan finance

to expand

their output and their employment

financial markets including the money

markets and the capital markets they

provide an intermediary

between

savers and borrowers essentially they

repackage the cash flows of savers

and allow people

to borrow money

the third role is really quite important

over time

an efficient financial market one that's

working well

with relatively few market failures

financial markets allocate funds for

productive uses so typically

if they're working efficiently the stock

market and the bond markets would

allocate scarce capital

to where the risk adjusted rate of

return on an investment

is highest of course that doesn't always

work out so you need to check out our

video on financial market failure

the fourth is if you like a

transactional function and that's to

facilitate the final exchange of goods

and services so many of you will use

your contactless payment card that's an

easy way for goods and services to be

purchased businesses need to be able to

facilitate trade and access export

credits and foreign exchange when they

when they need it

the fifth rule is to provide forward

markets in currencies and commodities so

forward markets is when for example you

can hedge against future price

uncertainty in particular markets and it

allows agents particularly corporations

uh to ensure a little bit against price

volatility

so forward markets are basically markets

where you can buy ahead of the game if

you like your currency or other assets

the sixth crucial role is to provide a

market for equities the capital market

that allows businesses to raise equity

and of course they can also raise debt

if they go to the capital market to fund

their investment

and their expansion

so here we have six

key roles of financial markets so they

can be applied pretty much to any any

country both high income advanced

countries and emerging nations