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Function of Financial Intermediaries Indirect Finance

Financial intermediaries play a key role in indirect finance by borrowing funds from savers and lending them to spenders. They help transfer money between these groups more efficiently than if savers and spenders interacted directly. While media focuses on stock markets, financial intermediaries are a far more important source of funding for corporations. The document then outlines the structure of financial markets, including different types of debt and equity instruments as well as primary and secondary markets. It discusses problems that can arise from asymmetric information like adverse selection and moral hazard between lenders and borrowers.

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Precious Joy
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91 views1 page

Function of Financial Intermediaries Indirect Finance

Financial intermediaries play a key role in indirect finance by borrowing funds from savers and lending them to spenders. They help transfer money between these groups more efficiently than if savers and spenders interacted directly. While media focuses on stock markets, financial intermediaries are a far more important source of funding for corporations. The document then outlines the structure of financial markets, including different types of debt and equity instruments as well as primary and secondary markets. It discusses problems that can arise from asymmetric information like adverse selection and moral hazard between lenders and borrowers.

Uploaded by

Precious Joy
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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• Function of Financial Intermediaries: Indirect Finance

Indirect finance is a route through which funds flow from lender-savers to borrower-spenders. It involves a financial intermediary that stands between lender-savers
and borrower-spenders and helps transfer funds from one to the other. More specifically, a financial intermediary borrows funds from lender-savers and then makes
use of these funds to make loans to borrower-spenders. The process of indirect finance using financial intermediaries, called financial intermediation, is the primary
route for moving funds from lenders to borrowers. Indeed, although the media focus much of their attention on securities markets, particularly the stock market,
financial intermediaries are a far more important source of financing for corporations than securities markets are.

• Structure of Financial Markets Debt Instrument


- contractual agreement by the borrower to pay the holder of the instrument fixed amounts at regular intervals (interest
1. Debt market and principal payments) until a specified date (maturity date), when a final payment is made ex. Bond or Mortgage
2. Equity market
3. Primary market Short-term if its maturity is less than a year
4. Secondary market Intermediate-term if its maturity is between one and 10 years
5. Exchanges Long-term if its maturity is 10 years or longer
6. Over-the-Counter (OTC) market
7. Money market Equities
8. Capital market - claims to share in the net income (income after expenses and taxes) and the assets of a business ex. Common Stock
- often make periodic payments (dividends) to their holders and are considered long-term securities because they have no
Equities vs Debt maturity date

Money Market Securities vs Investment Bank


Capital Market Securities - important financial institution that assists in the initial sale of securities in the primary market; underwrites securities

• Asymmetric Information
- inequality where one party often does not know enough about the other party to make accurate decisions

• Adverse Selection
- problem created by asymmetric information BEFORE the transaction occurs
- when potential borrowers who are the most likely to produce an undesirable (adverse) outcome—the bad credit risks—are the ones who most actively seek out a
loan and are thus most likely to be selected

• Moral Hazard
- problem created by asymmetric information AFTER the transaction occurs
- risk (hazard) that the borrower might engage in activities that are undesirable (immoral) from the lender’s point of view because they make it less likely that the
loan will be paid back

*The problems created by adverse selection and moral hazard are significant impediments to well-functioning financial markets.

• Conflict of Interest
- are a type of moral hazard problem that arises when a person or institution has multiple objectives (interests) and, as a result, has conflicts between those objectives

Economies of scope – financial intermediaries can lower cost of information production for each service by applying one information resource to many different services

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