The Role of Financial Markets and Financial Institutions Finance Essay

What is financial market? In the economics, the financial market is a mechanism that allows the people to sell and buy the financial commodities, securities and other fungible items of value at a low transaction costs and at prices that reflect the efficient-market hypothesis. The financial markets can be divided into different subtypes, there are capital markets, stock markets, bond markets, commodity markets, money markets, derivatives markets, future markets, insurance markets and foreign exchange markets. Next, the capital markets consist of the primary markets and the secondary markets.

The primary markets allow to buy or sold the newly formed securities. The secondary markets are allow the investors to sell their securities that they hold or buy the existing securities. 

In the financial market, the financial institution is an establishment that is focuses on dealing with the financial transactions, such as the loans, deposits and investments. The financial institutions are including the credit unions, banks, building societies, stock brokerages and management firms. The function of the financial institutions, such as the futures, commodity markets, currency, stock exchanges and options exchanges are very important for the economy. Those institutions are involved in the providing and creating ownership for the financial claims.

Next, those institutions are also responsible for maintaining the liquidity in the market and also managing the price change risks. Besides that, those institutions are also provide the investment opportunity and help the businesses to generate the funds for various purposes.

Third, the most important of the financial service provided by financial institutions are acting as financial intermediaries. 

The financial intermediation are consists of the “channeling fund between surplus and deficit agents”. The financial intermediary is a financial institution that connects the deficit and surplus agents. For an example of the financial intermediary is a bank that transform bank deposits into bank loans. There are several main function of the financial intermediaries, such as reduce the transaction cost, liquidity service (saving deposits or online banking to pay bills), risk sharing and asymmetric information (adverse selection, moral hazard) In a well-functioning economy, capital will flow efficiently from those who supply capital to those who demand it. 

The transfer of capital or fund can take place in the three different ways, there are direct transfers of money and securities, investment banking house and the financial intermediary.

First, about the direct transfers of money and securities, this is occur when a business sells their bonds or stocks directly to the savers, in the process they are no have go through any type of the financial institution. For an example, Mr. Yong, the proprietor of a Apple Sdn Bhd and he decides to sell the appliances, he need to buy the initial inventory such as washers, TV sets and freezers and that costs about RM 200,000. But he has only RM 100,000 in savings, so he direct to borrow the money from the other individual and without going any bank or the other intermediary. For an another simple example, if your friend lends you the money to help fund a new business after you graduate, this would be a direct transfer of fund.

The diagram below is show that the process of the direct transfers of money and securities. Savers Business Securities ( Stocks or Bonds ) Dollars Second, about the investment banking house, that is an organization that underwrites and distributes new investment securities and help the businesses obtain financing. The underwriter serves as a middleman and facilitates the issuance of securities. 

The process of the transfer in investment banking house is the company sells their bonds or stocks to the investment banking house and then the investment banking house sell to the savers the same securities. The savers money and the businesses securities are just passing through the investment, so it will have a risk because they may not be able to resell all the securities to the savers.

The diagram below show that how the businesses sell their securities to the saver by go through the investment banking house. Investment Banking Houses Savers Business Securities Securities Dollars Dollars Third, the most important of the financial service provided by financial institutions are acting as financial intermediaries. 

The financial intermediation are consists of the “channeling fund between surplus and deficit agents”. The intermediary obtains funds from savers in exchange for their own securities and they use this money to buy and hold the businesses securities. For an example, a saver might deposit the dollars in a bank, after than the bank might lend the money to a small business as a mortgage loan. There are several main function of the financial intermediaries, such as reduce the transaction cost, liquidity service (saving deposits or online banking to pay bills), risk sharing and asymmetric information (adverse selection, moral hazard) In a well-functioning economy, capital will flow efficiently from those who supply capital to those who demand it.

For an example about the transfer the securities between savers and business by go through the financial intermediary, if your family borrows the money to purchase a new car, you will probably raise the funds through a financial intermediary such as the local commercial bank or mortgage banker. 

The diagram below show that how the process of transfer the securities between savers and business by go through the financial intermediary. 

Savers Financial Intermediary Business 

Business’s Dollars Besides that, there are several classes of the financial intermediaries, such as Commercial Banks, Saving and Loan Associations (S&Ls), Mutual Savings Banks, Mutual Funds, Pension Funds and Life Insurance Companies. Commercial bank are providing many services, such as insurance and the stock brokerage services.

The commercial banks are very different if compare to the investment banks. 

The commercial banks is lend the money and the investment bank is help the company to increase their capital from other party. Second is the Savings and loan associations, they serve the commercial mortgage borrowers and the individual savers and they take fund from the small savers and lend the money to the borrowers, such as home buyer. Besides that, the S&Ls have more expertise in setting up loans, analyzing credit, and making collections. Third is the mutual savings banks, the mutual savings banks is similar to S&Ls, they operate primarily in northeastern states, lend mainly on a long-term basis to home buyers and consumers and accept savings primarily from individuals.

Next is the credit unions, they are the cooperative associations whose members are supposed to have the common bond, such as being the employees in same firm. They are also provide the cheapest source of the funds to the individual borrowers. After that is pension funds, it is a retirement plans that are funded by the government agencies and the corporations for their administered and worked by the trust of the commercial banks or by the life insurance companies. 

About the life insurance companies, they are take the savings in form of annual premiums and they invest these funds in stocks, bonds, real estate, and the mortgages and finally make payments to the beneficiaries of the insured parties. Last is the mutual funds, they are the corporations that accept money from savers and then use these funds to buy stocks, long-term bonds, or short-term debt instruments issued by businesses or government units.

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