Question

There are various types of financial institutions and intermediaries such as commercial banks, investment banks, mutual funds, hedge funds, pension funds, insurance companies, etc. Why are there so many different financial intermediaries other than commercial banks? How does an investor’s risk attitude and/or wealth play a role in his/her selection of a financial institution or intermediary? If you were an investor seeking moderate return for your investment, how would you select a financial institution or intermediary? Choose one and explain your reasoning. What are the main differences between mutual funds and hedge funds in their ways of investing? Hedge funds are not regulated by the Securities and Exchange Commission (SEC). What does this mean?

Answer 1

There are different financial institutions and intermediaries each serving a different purpose of the financial services value chain.

1. Commercial Banks - These banks are intermediaries between the depositors and the loan seekers, the interest differential is the profit of the bank.

2. Investment Banks - These banks help the companies in raising the money either from commercial banks as loans, or from the people or Insitiuations by issuing the debtor by helping in selling the equities of the company to raise the funds.

3. Mutual funds: Mutual funds are the firms that invest people's money directly into the equities or the debt of the companies with a view to providing a good return on investment for a small fee.

4.Pension funds: Pension funds are the funds specifically designed for the retirements

5. Insurance companies: These provide safeguard on investments, health, and life for a small number of fees.

As from the definition above each of the intermediary provides different value of financial services value chain, Commercial banks can just provide loans but what if some company wants to sell part of its company investment bank help in that, who will buy the part of the companies? mutual funds will buy. so every intermediatory has its own purpose.

As an investor one can deposit the money in the commercial bank which is less risky but that will fetch less return or he can invest in mutual fund where the moderate and returns will also be moderate or the hedge fund where the risk is moderate and returns are high but you require a lot of money for investment in it.

The main difference between the hedge fund and the mutual fund is: Hedge funds can invest all across the asset class like equity. debt, gold, property, etc. and gives you good returns with moderate risk while mutual fund can only invest in equities or debt or the mix of both.

The hedge funds are not regulated by SEC means they don't need to follow the rules, regulations, and compliance of the SEC.