Chap No. 2


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CHAPTER 2 CHAPTER 2 FINANCIAL INSTITUTIONS, FINANCIAL INSTITUTIONS, FINANCIAL INTERMEDIARIES, FINANCIAL INTERMEDIARIES, AND ASSET MANAGEMENT FIRMS AND ASSET MANAGEMENT FIRMS FINANCIAL INSTITUTIONS Financial institutions perform several important services: 1. Transforming financial assets acquired through the market and constituting them into a different, and more widely preferable, type of asset, which becomes their liability. This is the function performed by financial intermediaries. 2. Exchange financial assets for their customers, typically a function of brokers and dealers. 3. Exchange financial assets for their own account. 4. Create financial assets for their customers and sell them to other market participants—the underwriter this role. 5. Give investment advice to others and manage portfolios of customers. 6. Managing the portfolio of other market participants. Financial intermediaries including depository institutions , which acquire the bulk of their funds by offering their liabilities to the public mostly in the form of deposits, insurance companies, pension funds, and finance companies. ROLE OF FINANCIAL INTERMEDIARIES Intermediaries obtain funds from customers and invest these funds. Such a role is called direct investment . Customers who give their funds to the intermediaries and who thereby hold claims on these institutions are making indirect investments . A commercial bank accepts deposits and uses the proceeds to lend funds. Financial intermediaries, such as investment companies , play a basic role of transforming financial assets which are less desirable for a large part of the public into other financial assets which are broadly preferred by the public. By doing so they provide at least one of the following four economic functions: (1) providing maturity intermediation, (2) reducing risk via diversification, (3) reducing costs of contracting and information process, (4) providing a payment mechanism.
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Maturity Intermediation The customer (depositor) often wants only a short-term claim, which the intermediary can turn into a claim on long-term assets. In other words, the intermediary is willing and able to handle the liquidity risk more readily than the customer. This is called maturity intermediation . Risk Reduction Via Diversification By pooling funds from many customers the financial intermediary can better achieve diversification of its portfolio than its customers. Reduced Costs of Contracting and Information Processing Financial institutions provide expert analysis, better data access, and loan enforcement. Costs of writing loan contracts are referred to as contracting costs . Also there are information processing costs. They also benefit from economies of scale. Providing a Payments Mechanism
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