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


This is money which has been borrowed from a lender and is then repaid back to the bank with an added interest charge


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)


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