Box A1: Market-makers A market-maker is a broker-dealer firm that accepts the risk of holding a certain number of shares of a particular security in order to facilitate trading in that security. Each market-maker competes for customer orders by displaying buy and sell quotations for a guaranteed number of shares. Once an order is received, the market-maker immediately sells from its own inventory or seeks an offsetting order. This process takes place in mere seconds. Market-makers profit from the difference between what they buy and sell their shares for. In the UK, gilt-edged market makers (GEMMs) are licensed by the Government to deal in gilts (government bonds). There are currently 20 GEMMs in the UK and they are mainly larger investment banks-see http://www.dmo.gov.uk/index.aspx?page=Gilts/Gemms_idb for a full list. Market-makers play an important role in keeping the financial markets running efficiently because they are willing to quote both bid and offer prices for an asset.
Once a gilt has been sold to a GEMM on the primary market, it can be taken and resold on a secondary market. The secondary market is important because it makes a previously illiquid asset (a gilt with a fixed redemption date) liquid. Those who have bought gilts but wish to sell them before redemption can do so. This raises demand for bonds from the level they would have been at without a secondary market, and allows investors to hold liquid assets, whilst they still receive the benefits of having a fixed repayment date. Furthermore, the price of gilts in secondary markets is determined by genuine supply and demand rather than the primary market where GEMMS are required to both buy and sell gilts on demand at any time.14 This price mechanism conveys important information to investors that will also affect the primary market. As we have seen, government spending, via the Consolidated Fund, is usually financed by taxation and borrowing. In terms of intrabank payment, the process is no different from ordinary transfers, as described i n Section 4.3. If a customer buys bonds or pays tax, the money moves from their commercial bank account to the Governmentâ€™s bank account at the Bank of England via transfers of central bank reserves. At the end of each working day, any public funds in the Exchequer Pyramid (Figure A3) at the Bank of England are â€˜swept upâ€™ to the NLF, which itself is swept into the DMA. The Debt Management Office (DMO) has an agreement with the Bank of England to hold a certain cash balance every night to offset any late or unexpected outflows. If it exceeds the targeted balance, the DMO invests the surplus on the money markets until it is needed; if it is short of the target, it borrows the shortfall through the overnight or longer-term money markets. If public bodies do not minimise the balances in their own accounts with commercial banks and place funds in their Exchequer accounts, the amount of net government borrowing outstanding on any given day will be appreciably higher, adding to interest costs and making the fiscal position worse.15 In 2004, the Bank of England announced that by the end of 2009 it would stop providing retail banking services and focus on its core purpose of maintaining monetary and fiscal stability. The Government Banking Service was launched in May 2008. It incorporates the Office of HM Paymaster General and is
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