Question

Briefly discuss the purpose and role that each type of financial institutions (depositary, contractual, and investment) play in the U.S. economy. How do each of these institutions intersect with the various types of markets, i.e., capital, money, spot (cash), derivatives, Forex and Interbank, primary, and secondary (inclusive of OTC)?

Answer 1

A depository institution is located in the United States and can accept money from depositors. There are several different types of depositories. You have credit unions, banks and savings and loans associations. Most of the assets of banks can be grouped into four categories. These are cash, securities, loans and other assets. Other assets include real property such as equipment, buildings and land. Most of a bank’s assets are in the form of loans with a large portion in securities. Banks hold securities to earn additional reserves. Banks have to meet reserve requirements set by the Federal reserves. Banks have to keep a certain amount of cash in their federal reserve. This is called required reserves.Contractual institutions are insurance companies and pension funds. They get funding from long term contractual arrangements and then they invest these funds on the capital market. They have a steady inflow of funding and can make long term investments in securities. Some examples of this are life and casualty insurance as well as pension funds. Insurance companies have first type and second type. First time is a mutual company or a stock company. Second type is property and casualty insurance. Pension funds are another type of savings institution. They are regulated by federal and state.Investment banking was separated from commercial banking in 1933. Investment banking creates capital for other companies, government and entities. They underwrite new debt and aid in the sale of securities. They help facilitate mergers and acquisitions, reorganizations and broker trades for institution and private investors. They also provide guidance to issuers regarding the issue and placement of stock. They serve as a middle man between companies and investors when the company wants to issue stocks or bonds.

CAPITAL MARKETS

A capital market is one where individuals and institutions trade financial securities. Each country has their own capital markets which can vary in size and growth, capital markets in Africa may be different from those in Europe or America. Often, organizations and institutions in both the public and private sector sell securities on the capital markets in an attempt to raise funds.

MONEY MARKET

The money market is just one asset to the financial market where financial instruments that tend to have high liquidity and short maturities are traded between banks or other financial institutions. To put it simply, the money market is used to borrow and lend money for up to just under a year. Whilst investors are prepared to take more risk and tolerance when it comes to investing in capital markets, money markets are a great alternative to hold funds that ae required in a shorter period of time.

CASH OR SPOT MARKET

In this highly complex yet vulnerable market, it is a rule that items sold for cash and contracts that are either bought or sold on the market are delivered and implement immediately. Compared to other markets, the cash or “Spot” market prices are established in cash at the current market price whereas other trades are usually settled at forward prices, meaning that those who decide to invest can either be rewarded with a big gain or suffer from a large loss. The New York Stock Exchange is an example of a regulated cash market andthis stock exchange is also a rare example of a market that is safe from automation.

DERIVATIVE MARKETS

The derivative market is called the ‘derivative’ for a reason because its value is acquired based on its underlying asset or assets. Although a derivative is a contract, the contract price is set based on the market price of the core asset. For inexperienced traders seeking to speculate, the derivative market is not ideal due to its complexity but can be used as part of a risk management program protect against the risk of an adverse move.

FOREX & INTERBANK MARKET

The interbank market is part of the financial system and currency trading performed between banks and financial institutions, not including retail investors and small trading parties. Although some interbank trading is executed between banks on behalf of a large customer, the majority of interbank trading occurs from the banks own account.

PRIMARY & SECONDARY MARKETS

The primary market is where a majority of investors have their first opportunity to engage in a new security issuance. The funds that are gained from the sale by the issuing company or group is used to fund operations or develop the business where as the secondary market is where investors buy securities or assets from investors as opposed to issuing companies on their own. So essentially, the primary market is the place for new shares and the secondary market is where formerly issued securities must be traded that can be sold multiple times by investors.

THE OTC MARKET

Otherwise called the over-the-counter market, the OTC is a type of secondary market which may be referred to as a dealer market, used to describe stocks that are no longer trading on stock exchange and are usually are traded for companies that don’t fit the criteria to list on a stock exchange. Although OTC market involves trading of financial instruments including stocks, commodities and currencies, it is performed directly between two parties without administration of an exchange.