The role of Financial Markets – Economics Revision – The Tutor Academy
The role of Financial Markets – Economics Revision – The Tutor Academy
Courses Info
Level: AS Levels, A Level, GCSE – Exam Boards: Edexcel, AQA, OCR, WJEC, IB, Eduqas – Economics Revision Notes
The Key functions of a Financial Market
1. Lending to businesses and individuals
- Financial Markets act as a third party platform between savers and borrowers to facilitate lending
2. To facilitate saving
- Financial Markets provide households and businesses with a range of accounts for them deposit money into and also earn interest from
3. To facilitate the exchange of goods and services
- Financial Markets allow for several transactions to take place; such as, consumers to make payments in shops, people to settle debts and workers to receive wages
- It also enables transaction methods like performing a contactless payment, to be carried out
4. To provide a market for equity
- Financial Markets allow businesses to fund their capital investment by raising equity
5. To provide forward markets
- Firms are able to buy and sell in the future at a set price
AQA Spec – Additional Content
The difference between Debt and Equity
Debt
This is money which has been borrowed from a lender and is then repaid back to the bank with an added interest charge
Equity
This is a stock or security owned with no outstanding debt – it can be sold for cash at any point in time
Why is there an inverse relationship between market interest rates and bond prices
- Money is lent to the issuer when a bond is bought – who then agrees to pay the value of the bond back once it matures, and interest payments which are charged periodically
- When the bond is issued, the rate of interest is fixed
- New bonds will have rates close to the market interest rate
Fall in market interest rate
- A fall in the market interest rate will imply that the bond increases in value
- The bond will hold an interest rate higher than the current market conditions, hence is worth more
Increase in market interest rate
- A higher market interest rate implies that the value of the bond will fall
- The bond will hold an interest rate lower than the market interest rate, hence will be worth less
OCR Spec – Additional Content
The Harrod-Domar Model
- In order for economic development to occur in emerging and developing countries, a secure financial sector is essential as this allows consumers and firms to generate sufficient savings
- In developing countries, wealth s limited as individuals can only afford to spend money in the short run; therefore, consumers focus on their immediate needs rather than planning for long term investments
- Inadequate capital accumulation arises with insufficient savings
- The Harrod-Domar Model suggests in order for economic growth to occur, it is essential for there to be investment, savings, and technological change
- As the savings ratio increases, so does the rate of growth – leading to investment, technological progress and higher productivity
- Rate of Growth = (savings ratio / capital output ratio)
Limitations of the Harrod-Domar Model
- Paradox of Thrift – although an increase in savings can lead to an increase in investment, more savings may also imply less spending, which leads to a decrease in aggregate demand
- Low Marginal Propensity to save – there may be inefficiency on the workforce and funds may not lead to borrowing & investment
Quick Fire Quiz – Knowledge Check
1. Identify and explain four key functions of a Financial Market (8 marks)
Next Revision Topics
A Level Economics Past Papers
