Question

What are the economic functions that are provided by the various financial instruments? Please compare and contrast two instruments in either the money market or the capital market. What are the economic functions that are provided by the various financial institutions? Please compare and contrast two financial institutions.

Answer 1

Economic Functions of Financial Institutions

Financial institutions are assets that are expected to yield a future benefit. These assets are tradeable and also represents the legal agreement and right of the monetary value and the ownership of the asset. There are many financial instruments like cash instruments and derivate instruments. Financial markets have a greater role to play in the economic stability of a nation. Below given are two main economic functions of financial institutions in general.

1. It facilitates the transfer of funds from individuals with surplus funds to invest to those ehwo wants a source of assets

2. It helps in the redistribution and transfer of risk associated with the investment according to individual preferences and risk aversion.

Comparison of Bonds and Equities

Bonds: Bonds are the loans that are given to large companies which includes corporates, muncipal, governments etc. Bonds are considered as fixed income investments. In case of bankruptcy bonds are given much more preference than stocks. The investors earn interest every month and the final principal amount is received when the bond is matured. Hence there is an inverse relationship between bond prices and interest rates. When the interest rate goes up, the bond prices falls. Corporate bonds are considered riskier than government bonds and because of this reason corportate bonds have higher interest rates. Compared to stocks, the prices of bonds are less volatile.

Equities: Equities are the amount of money that will be returned to the companies shareholders if all the assets of the firm are liquidated and after clearing off the debits of the company. It can be also considered as the value of the company. Equities are included in the balance sheet of the company. Equity is the ownership in a firm after deducting the debts. Equities are popular because of the high returns. There also exists a higher level of risks associated with the equities. The different types of equities are shares, equity mutual fund investment, large cap equity funds, midcap equity funds, arbitrage schemes etc. The share of individuals can be collected or redeemed only after the company's liquidation. As a result of investing in the company's shares, the individuals have a right to claim on the company's income.