Question

What are the economic functions that financial intermediaries perform that benefit society?

In your answer, discuss the relationship of financial intermediaries and financial markets to the savings-investment process within an economy and to each other. As part of your discussion provide an analysis of the differences in preferences among economic agents as an explanation for the wide variety of primary and secondary securities found in financial markets. Be sure to explain how depository intermediaries, like banks, differ from other financial institutions such as investment banking firms or securities brokerage companies, and how financial intermediaries profit from the transformation of primary securities into secondary claims.

Carefully, DEFINE YOUR TERMS.

Answer 1

Financial Intermediaries

• A financial intermediary refers to a business entity that plays the role of a middleman in the procurement of financial transactions between two parties. They include mutual funds, investment, and commercial banks

• There are several benefits attached to involving an intermediary when conducting a financial transaction, which are liquidity, safety, and economies of scale which are involved in asset management. However, advancement in technology is a major threat that can lead to the elimination of financial intermediaries in the financial market.

• A financial intermediary in the economy is a key player that interacts with borrowers and lenders to promote and enable the transformation of liabilities into assets. This process that entails the transformation of liabilities into assets is known as intermediation, where the financial intermediaries facilitate indirect borrowing and lending between both parties since direct lending is relatively inefficient

• This explains the relationship that exists between financial intermediaries and financial markets where the facilitators of indirect lending concurrently lower transaction cost as they also minimize the risk of lending by savers.

• This explains the relationship that exists between financial intermediaries and financial markets where the facilitators of indirect lending concurrently lower transaction cost as they also minimize the risk of lending by savers.

• Primary securities refer to the assets that are created from a credit institution extended to a fund borrower and they associate directly with the borrower's project. Secondary securities are assets that have already been traded in the financial markets and are not new to the market. Financial institutions are classified into three, depository institutions, pension funds and insurance companies, and government financial institutions Depository institutions accept customer deposits and manage them and offer loan services.

• Insurance companies provide customer protection against risks as pension funds manage pensions and prepare pension plans. All these financial institutions have regulations to ensure that customers are assured of safety as they put their money in those financial institutions.

• The reason behind the provision of federal and state regulations is to promulgate rules for the industry, cutting across depository institutions, pension funds, and insurance companies, and oversee their compliance with the regulations

• All this is in a bid to facilitate customer protection. Asset-backed securities draw together financial assets in the form of a pool to trade them together because they otherwise could not be traded in their original form.

• Securitization is advantageous in the reduction of transaction costs through the creation of a financial claims market in the capital market. It also promotes the saving of intermediation costs by redefining the role of intermediaries, but not eliminating intermediation.

• Interest rates are deemed to cause an impact on a customer's expenditure. High rates of interest reduce the consumption level through substitution, rendering current consumption more expensive. This increases aggregate savings since people want to spend less today in consideration of tomorrow.