Financial Markets | A-Level Economics Notes

These revision notes cover everything you need to know about Financial Markets for A-Level Economics. They're designed for students studying AQA A-Level Economics, Edexcel A-Level Economics, and Edexcel International A-Level Economics. Written by Jaisul Naik, UCL Economics graduate and A-Level Economics tutor since 2017.

What is the role of financial markets?

1. facilitate borrowing and saving
2. facilitate the exchange of goods and services
3. provide forward markets
   1. this allows firms to buy currencies delivered in the future
   2. at a price that is agreed in advance
4. provide a market for equities

Explain what happened in the global financial crisis

1. Banks were targeting profitability so they were offering a lot of 'subprime' mortgages
2. This is caused by moral hazard, which is when companies are incentivised to increase risk as the consequences can be passed onto others.
3. This led to an increase in demand for housing
4. Mortgage companies bundled mortgages together as an asset and sold them to banks worldwide. They had asymmetric information.
5. This allowed companies to provide even more subprime mortgages.
6. House prices increased rapidly and this formed a bubble
7. Over time, banks and people realised that these mortgages were high-risk.
8. This caused panic and led to a bank-run
9. Banks ran out of cash leading to a liquidity crisis. They stopped further lending.
10. This led to a fall in consumer confidence and business confidence.
11. This led to a demand-side shock across the economy.

What is the role of the central bank?

The financial crisis caused externalities. The central bank stepped in as the lender of last resort in order to prevent the financial crisis spreading even further.

Financial market failure has huge systemic risk as so many banks are inter-linked.

1. a lender of last resort
2. in control of monetary policy
3. banker to the government
4. banker to banks
5. regulation of financial markets

What does the PRA do?

The PRA is part of the Bank of England. They help to ensure that banks do not get themselves into financial trouble by ensuring they manage their risk and capital.

What does the FPC do?

The FPC is also part of the Bank of England. It helps to control financial markets from systemic risk.

What does the FCA do?

The FCA is separate from the Bank of England. The FCA ensures consumers are treated fairly in financial markets.

What is a capital ratio?

A capital ratio is the minimum amount of capital that banks have to hold relative to their risky assets.

What is a liquidity ratio?

A liquidity ratio is the amount of liquid assets a bank has relative to its overall assets.

Summary questions

1. What is the role of financial markets?
2. Explain what happened in the global financial crisis
   1. asymmetric information
   2. externalities
   3. moral hazard
   4. market bubbles
3. What is the role of central banks?
4. What does the PRA do?
5. What does the FPC do?
6. What does the FCA do?

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