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2.4 Financial markets and
monetary policy
2.4.1 The structure of financial markets
and financial assets
Characteristics of money
Durability i.e. it needs to last
Portable i.e. easy to carry around, convenient, easy to use
Divisible i.e. it can be broken down into smaller denominations
Hard to counterfeit - i.e. it can’t easily be faked or copied
Must be generally accepted by a population
Valuable – generally holds value over time
Key functions of money
1. Medium of exchange - we no longer need to barter for goods and services.
2. Store of value - can be stored or invested in now and spent later.
3. Unit of account - measure of value, items can be compared.
4. Standard of deferred payment - expresses value of debt/loans.
Money supply
Money supply = the total amount of money in circulation or in existence in a country.
2.4 Financial markets and monetary policy 1
, Liquidity - the ease at which an asset can be converted into cash without loss of
value.
Narrow money
A measure of the value coins and notes in circulation and other money equivalents
that are easily convertible into cash such as short term deposits in the banking
system.
The most liquid part of money supply; cash and easily accessible bank and building
society deposits (current accounts).
Broad money
A measure of the total amount of money held by households and companies in the
economy.
Includes narrow money and adds more illiquid assets; deposits that are harder/take
more time to turn back into cash.
Financial markets
2.4 Financial markets and monetary policy 2
, The money market
Money markets are markets where highly liquid, short-term (maturing between day 1
and 1 year) financial assets are traded. These include commercial and Treasury
bills.
Market for short term loan finance for businesses and households
Money is borrowed and lent normally for up to 12 months
Includes inter-bank lending i.e. the commercial banks providing liquidity for each
other
Includes short term government borrowing e.g. 3-12 months Treasury Bills – to
help fund them government’s budget (fiscal) deficit
Capital markets
Capital markets are for medium to long-term financial instruments. This is where
PLCs (public limited companies) raise finance by issuing shares or bonds (primary or
new issue markets); where these shares/ bonds are then subsequently sold on
(secondary markets); and where the government raises finance by issuing bonds (to
finance a budget deficit, for example). To do this, shares/bonds need to be attractive
to investors. Without the facility to easily sell them on, they would be a lot less
attractive. Hence the need for secondary markets as well as primary markets.
Market for medium-longer term loan finance
Capital markets are the markets where securities such as shares and bonds are
issued to raise medium to long-term financing
2.4 Financial markets and monetary policy 3
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