Question

Question 3:

What are the various ways through which transfer of capital takes place between the savers and investors? Discuss with the help of examples.

Answer 1

Capital is the backbone of any economy. Without capital investment the economy of country cannot be developed. The transfer of capital from savers to investors takes place through many financial institutions(FIs). These FIs play an important role in channelizing the capital from savers to investors.

The role of various FIs in this channelizing can be described below:

1) Banks - Banks are the primary source of capital for investors. The banks attract saving from general public in form of deposits, which they transfer to investors, corporates, as loans. The savers get some interest on these deposits and the bank charges interest from investors, thus making a profit. Its like a win win situation for all.

2) Capital market - This includes primary as well as secondary market. The companies can raise capital from the primary market by way of Initial Public Offer (IPO) to general public ,FIs. The capital so raised is called share capital. The public or FIs get share in the share capital of the firm.They invest in IPOs for earning dividends or capital appreciation.

The trading of these securities is done in secondary market so that any shareholder can exit from the investment. In Secondary market a company can raise further capital or may buy back capital. Secondary market plays an important role in giving liquidity to the investors, savers. The companies / investors always try to give better return to their shareholders so that their share prices perform better.

3) Insurance Firms - The insurance firms provide insurance to the general public, businesses, and other institutions.Their are various types of insurance like life,general,social,guarantee. They collect premium for insurance services, which they invest in other markets based on certain guidelines from the regulatory bodies. They invest in capital markets, FIs, corporate bonds etc. Thus channelizing capital from savers to investors.

4) Mutual Funds - Mutual funds also channelize capital by attracting savers to invest in their schemes. The funds so collected are invested in stock market to get return. Thus transferring capital from savers to investors indirectly.

5) Government bonds - Government issues bonds to collect funds from general public, other FIs ,for investing in development purposes. Examples like municipal bonds, T-Bills etc. These bonds provide some yield to the investor.