FINANCIAL MARKETS AND INSTITUTIONS REPORT 7
FinancialMarkets and Institutions Report
Roleof Financial Institutions in the Economy
Afinancial institution refers to an organization that is concernedwith monetary dealings like savings, deposits, and issuance of loans.People deal with these enterprises on a daily basis as they carry outtheir day-to-day businesses. Their functions vary depending on thetype of institution. Commercial banks take deposits from theircustomers as well as offer security for their money which helps inminimizing the risk of money being stolen. Depositing money withcommercial banks also benefits clients because their money earnsinterest unlike when the cash is kept at home where no interest isearned (Carmichael & Pomerleano, 2002). Furthermore, commercialbanks help the economy through offering loans to the public which isused in starting new businesses in the economy. When investmentsincrease, they help in creating more jobs thus reducing the rate ofunemployment, especially among the youths. Moreover, these banks playthe under-appreciated function which is making payments between onenation and another.
Insurancecompanies are organizations that collect premiums from people inorder to shield them from losses. These institutions help individualswho wish to guard themselves against specific losses such as death,disabilities, sickness, fire or accidents. The companies areimportant in an economy because they help in restoring people back totheir financial positions which guarantee continuity of businesses inthe economy (Carmichael & Pomerleano, 2002). For example, if anenterprise is destroyed by fire, the owner gets money to restore thebusiness again. Therefore, these companies offer risk management inthe economy.
Furthermore,financial institutions help in offering liquidity in the economy.They offer liquidity through demand deposits which customers canwithdraw anytime when they are in need of cash. Through the banks,clients can buy government securities and bonds which help incontrolling inflation in the economy. Also, financial institutionsgive out real estate loans which assist people in acquiring decenthousing in an economy thus reducing the housing problems in acountry.
Rolesof Financial Markets in the Economy
Financialmarket refers to a place where buyers and sellers are involved in thedealings of derivatives, equities, currencies, and bonds. Almostevery economy in the world has financial markets. There are differentfinancial markets whose functions vary. There is a capital marketwhere people and institutions buy and sell monetary securities.Institutions, whether privately or publicly owned, can use thecapital markets to raise funds through the sales of securities. Thegovernments also sell bonds and securities through the capitalmarkets to get money to finance their operations (Dickinson, 2015).
Moreover,the stock market helps companies in raising capital as well ashelping potential investors in earning profits through the dividendsthat investors get (Dickinson, 2015). Through the stock markets,people can buy shares of public companies. Furthermore, the bondsmarket assists the government in selling its bonds to the public toreduce too much money in the economy, as well as buying the samebonds from the public when there is decreased cash in the economythus stimulating investments in an economy. Besides, bonds help thegovernments to finance projects that will generate more money andcreate more job opportunities as a way of boosting the GDP in acountry.
Amoney market is a form of financial market in which assets that arehighly liquid are traded. In the money markets, participants benefitfrom borrowing and lending of short-term loans. This market helpsbusinesses to raise additional capital when they trade commercialpapers. Furthermore, individuals can keep their money in the moneymarkets for a short duration in the form of Certificates of Deposits(CDs) which is safer than keeping the money at home where it can belost or stolen.
Themortgage markets play a vital role in the economy by offeringparticipants access to long-term financing that is used to acquireproperties. When the financing is made it can be bought and sold inthe second-hand mortgage market which can assist the initial lendersin recovering the lost liquidity (Carmichael & Pomerleano, 2002).Moreover, insurance markets are important in the economy because theydeal with the transfer of risk from the insured to the insurer. Thisensures that people are confident in pursuing the businesses thatthey want because incase of any loss, but it was insured against,business owners will be compensated. Therefore, insurance marketsguarantee that there is the stability of businesses in the economy.
TheDifferences between Primary Market and Secondary Market
Aprimary market is a place where shares are offered for the first timeby a company to investors during the initial public offer while thesecondary market is a place where investors buy shares from theinvestors who had already bought the shares in the primary markets.Also, the prices of shares in the primary market are constant while,in the secondary market, prices are determined by the market forces(Dickinson, 2015). Besides, the cash that is earned from the sales ofshares in the primary market is revenue for the company while in thesecondary market the cash obtained from shares is money for both thecompany and investors. Moreover, investment banks are involved in theselling of shares in the primary market, but in the secondary market,brokers are the intermediaries when investors buy and sell sharesamong themselves. Finally, shares can be sold for only once in theprimary market while in the secondary market shares can be traded foras many times as possible.
TheDifferences between Money Market and Capital Market
Inthe money market, the lending and borrowing period is less than orequal to one year while the capital market deals with the lending andborrowing of money for more than one year. The main function of themoney market is liquidity adjustment, but the capital market is alsoresponsible for engaging the capital in constructive uses mostly tocreate more jobs in the economy (Bhole & Mahakud, 2009). In themoney market, banks are often monitored closely, but in the capitalmarket, the financial institutions are not monitored as much. Theinstitutions that are found in the money market are non-bankingfinancial institutions, the central bank of a country, and acceptancehouses. On the other hand, the institutions that are found in thecapital market are insurance companies, building societies, and thestock exchange. The money market mostly deals with call money, billof exchange, and security loans while the capital market is concernedwith government securities and bonds, shares, and debentures. Thecredit instruments present in the capital market are more dissimilarthan those found in the money market (Bhole & Mahakud, 2009). Themoney market is closely linked to the central bank of a country, butthe capital market only feels an indirect influence from a centralbank.
Bhole,L. M. & Mahakud, J. (2009). Financialinstitutions and markets: Structure, growth and innovations.New Delhi: Tata McGraw-Hill.
Carmichael,J. & Pomerleano, M. (2002). Thedevelopment and regulation of non-bank financial institutions.Washington, D.C: World Bank.
Dickinson,K. (2015). FinancialMarket Operations Management.Chichester, West Sussex, United Kingdom : John Wiley and Sons, Inc.