AQA A-level Economics: Financial markets, financial assets, money and bonds (7136) – Revision Notes

These notes condense the AQA AS and A-level Economics specification (version 1.3, 29 June 2022), A-level sub-section The structure of financial markets and financial assets (4.2.4.1 in the combined PDF; 3.2.4.1 on the AQA website). The study guide gives full explanations and worked examples, and the practice questions test them. The course page is AQA A-level Economics, the printable checklist tracks coverage, and the free 10-minute diagnostics reveal weak spots. Banks, credit creation, regulation and central bank policy belong to other units. All figures are invented and illustrative.

Money

Money: anything that people generally accept when buying goods and services or paying off what they owe.

Characteristic	Meaning
Acceptability	Everyone takes it
Durability	Survives repeated use
Portability	Easy to carry and transfer
Divisibility	Matches large and small prices
Uniformity	Every unit is the same
Limited supply	Not freely created, so it holds value
Stable value	Buys about the same over time

Function	One-line test
Medium of exchange	Used to buy and sell; ends the double coincidence of wants
Store of value	Purchasing power held for later; weakened by inflation
Unit of account	All prices stated in one measure
Standard of deferred payment	Debts and contracts fixed in money terms

Narrow and broad money

	Narrow money	Broad money
Content	Notes and coins held by the public and, in many definitions, banks’ balances at the central bank	Narrow money plus other bank and building society deposits, and in some definitions other liquid assets
Liquidity	Highest: spend at once	Some parts need notice or a switch first
Relationship	A subset of broad money	The wider measure

• Definitions differ between countries and over time. Use the one in the question.
• Liquidity: how quickly and cheaply an asset becomes spendable money without losing value.
• Moving funds between deposit types inside broad money does not change broad money. Withdrawing cash from a deposit raises narrow money but leaves broad money unchanged.

The three markets

Market	Traded	Maturity	Price
Money	Short-term loans and assets, such as treasury bills and lending between banks	Up to about a year	Short-term interest rates
Capital	Shares and bonds	Long term (shares have no maturity)	Share prices; bond prices and yields
Foreign exchange	Currencies	Not applicable	Exchange rates

• Primary market: new issues, raising funds for the issuer.
• Secondary market: trading in existing assets between investors. It gives liquidity but raises no new funds for the issuer.

Role of financial markets

1. Channel savings to borrowers who invest.
2. Provide liquidity through secondary markets.
3. Give price signals (interest rates, yields, share prices) that steer funds.
4. Spread and price risk.
5. Make international trade and investment possible through currency exchange.
6. Let government borrow through bonds.

Chain: lower cost of finance → more projects worth doing → more investment → higher capital stock → higher aggregate demand now and long-run aggregate supply later.

Evaluation points: mispricing, speculation, herd behaviour, bubbles, uneven access for small firms, and dependence on regulation.

Debt versus equity

	Debt	Equity
Return	Interest (fixed obligation)	Dividends (discretionary)
Repayment	Yes, at maturity	No
Ownership or control	None	Yes, usually voting rights
Risk to firm	Higher	Lower
Paid first if firm fails	Yes	No

Ways firms raise finance: issue shares; issue corporate bonds; borrow from a bank.

Worked reminder: loan or shares? Firm F has 50,000 shares and needs 200,000. A loan costs 5% (interest 10,000); new shares would be sold at 5 each (40,000 new shares, 90,000 in total).

Profit before interest	Profit per share, loan	Profit per share, shares	Interest cover
96,000 (expansion works)	(96,000 − 10,000) ÷ 50,000 = 1.72	96,000 ÷ 90,000 = 1.07	9.6
30,000 (downturn)	(30,000 − 10,000) ÷ 50,000 = 0.40	30,000 ÷ 90,000 = 0.33	3.0

Debt is cheap here and cover stays comfortable, so the loan wins in both cases. A higher interest rate or lower profit would weaken that case.

Evaluate the choice using: stability of profit, existing level of borrowing, interest rates, wish to keep control, and how fast funds are needed.

Bonds: terms and formula

Term	Meaning
Nominal (face) value	Amount repaid at maturity; prices quoted per 100
Coupon	Fixed annual payment, a percentage of nominal value
Maturity	Repayment date, or time left until then
Market price	Secondary market price; may differ from nominal value

Yield = annual coupon payment ÷ market price × 100

Method: calculate a yield

1. Find the annual coupon payment in money terms (coupon rate × nominal value).
2. Divide by the market price paid.
3. Multiply by 100 and state the percentage.

Worked reminder. Coupon 7 per 100 nominal. Price 112: 7 ÷ 112 × 100 = 6.25%. Price 70: 7 ÷ 70 × 100 = 10%.

Method: explain the inverse relationship

1. The coupon is fixed when the bond is issued.
2. Market interest rates rise, so new bonds offer more.
3. The old bond is less attractive; demand falls and sales rise.
4. Its price falls until its yield matches the market rate.
5. The reverse happens when rates fall.

Worked reminder. Irredeemable bond, coupon 3. At market rate 6%, price = 3 ÷ 0.06 = 50. If the rate falls to 4%, price = 3 ÷ 0.04 = 75, a rise of 50%.

The bond market in words

Draw price on the vertical axis and the quantity of bonds on the horizontal axis. Demand slopes down and supply slopes up. A bond with coupon 4 starts at price 100, a yield of 4%. A rise in market interest rates shifts demand for existing bonds to the left, because new bonds are better value. The new equilibrium price is 80, a yield of 4 ÷ 80 × 100 = 5%. The lower price is what restores the yield to the market rate.

Linking to the wider economy. Higher yields mean government pays more to borrow, and firms face a higher cost of finance. A fall in yields lowers both costs.

Must-know distinctions

• Coupon is fixed; yield and price move.
• Yield rises when price falls.
• Longer maturity means a bigger price change for the same change in interest rates.
• Selling early realises a loss; holding to maturity returns the nominal value.

Quick self-test

1. List the functions of money.
2. A bond has a coupon of 7 per 100 nominal and sells at 112. Calculate the yield.
3. An irredeemable bond with coupon 3 sells at 60. Calculate the yield.
4. Market rates fall from 6% to 4%. Calculate the price change of an irredeemable bond with coupon 3.
5. State one difference between narrow and broad money.
6. Which market deals with lending that is repaid within a few months?
7. State two differences between debt and equity.
8. Calculate the annual coupon on 20,000 nominal of a bond with a 4.5% coupon.
9. An irredeemable bond has coupon 6. What price gives a yield of 8%?
10. Why does a holder of a bond who keeps it to maturity not lose from a rise in interest rates?

Answers

1. Unit of account, medium of exchange, store of value, and standard for deferred payment (debts fixed in money terms).
2. 7 ÷ 112 × 100 = 6.25%.
3. 3 ÷ 60 × 100 = 5%.
4. Price rises from 50 to 75, a rise of 50%.
5. Narrow money is the most liquid (notes and coins, and in some definitions bank balances at the central bank). Broad money adds other deposits and is less liquid.
6. The money market.
7. Debt must be repaid and pays interest; equity is not repaid and pays discretionary dividends. Debt gives no ownership; equity gives ownership and votes.
8. 20,000 × 0.045 = 900.
9. 6 ÷ 0.08 = 75.
10. They still receive every coupon and the nominal value at maturity, so only the opportunity cost of not holding a higher-yielding bond remains.

Evaluation prompts

• Short run or long run? Bond price changes are immediate. Effects on investment and growth arrive later.
• Who? Savers, borrowers, firms and government are affected differently.
• How large? Longer maturity means a bigger price move; high gearing means a bigger risk.
• Stable or uncertain conditions? Debt suits steady profit. Equity suits uncertain profit.
• Regulation and confidence. Financial markets work well only when investors trust the information and rules.

Where marks are usually lost

• Listing functions or characteristics without applying them to the context.
• Treating narrow money as “cash only” without noting that definitions vary.
• Calling the money market and capital market the same, or splitting them by size instead of time.
• Dividing the coupon by nominal value when the price is given.
• Treating the coupon as variable.
• Saying bond prices and interest rates are positively related.
• Explaining the fall in price without the link to new bonds and demand.
• Describing the role of financial markets as a list with no chain of reasoning or evaluation.

Official syllabus

AQA AS and A-level Economics specification, version 1.3 (29 June 2022), published by AQA: A-level content, The structure of financial markets and financial assets (4.2.4.1 in the combined PDF; 3.2.4.1 on the AQA website).