In varying degrees, all business firms operate within the financial system. When a product or service is sold, the seller receives either cash or a financial asset in the form of an account receivable. In addition, the firm invests idle funds in marketable securities, and here it has direct contact with the financial markets. More importantly, most firms use financial markets to finance their investment in assets. In financial analysis, the market price of a company's securities is the test of whether it is a success or a failure. While business firms compete either each other in the product markets, they must continually interface with the financial markets. The financial market consists of a number of institutions and markets serving business firms, individuals, and governments.
1.1 THE PURPOSE OF FINANCIAL MARKETS
The purposes of financial markets are to make sure the financial assets exits in an economy because the savings of various individuals, corporations, and governments during a period of time differ from their investment in real assets. By real assets, it means things such as houses, buildings, equipment, inventories, and durable goods. A financial asset is created only when the investment of an economic unit in real assets exceeds its savings and it finances this excess by borrowing or issuing equity securities. For sure there will b another unit willing to lend. This interaction of borrowers with lenders determines interest rates.
Purposes of financial markets in an economy are to allocate savings efficiently to ultimate users. The more diverse the patterns of desired savings and investments among economic units, the greater the need for efficient financial markets to channel savings to ultimate users. Efficient financial markets are absolutely essential to assure adequate capital formation and economic growth in an economy. If there were no financial assets other than money, then each economic unit could invest only to be the extent that it saved.
1.2 FINANCIAL INSTITUTIONS
Commonly, you need a medium to transfer money from one person to another person. The medium, we can call it as financial institutions. It means the transfer of capital between the savers and those who need capital. There are three different says where this process takes place. The ways are direct transfer of money, investment banking house and also financial intermediaries. If you need any capital or to borrow, you can find for these people.
Among the number of institutions involved in the financial system, only a handful invests heavily in the securities of business firms. In what follows, we concentrate on those institutions involved in buying and selling corporate securities.
1.3 DIRECT TRANSFERS OF MONEY AND SECURITIES
Direct transfer of money can be defined as the process occurs when a business sells its stock or bond directly to savers without going through any type of financial institutions. This business delivers its securities to savers, who turn give, the firm the money it needs.
1.4 INVESTMENTS BANKING HOUSE
Investment banking house can be defined as an organization that underwrites and distributes new investment securities and help business obtain financing. For an example, Merrill Lynch who underwrites the issue. An underwriter serves as a middleman and facilities the issuances of securities. The company sells its stock or bonds to the investment bank, which in turn sells these same securities to savers.
1.5 FINANCIAL INTERMEDIARIES
From now, we have considered only the direct flow of savings from savers to users of funds. If there are financial intermediaries in an economy, the flow can be indirect. Financial intermediaries transform funds in a way that makes them more attractive. A variety of services and economies are provided. Economies of scale are possible and may be passed on to borrower and lender in the form of lower cost of operations. A financial intermediary also is able to pool savings to purchase primary securities of varying sizes. The financial intermediary provides often needed expertise in investing in primary securities. Thus, financial intermediaries tailor the denomination and type of indirect securities they issue to the desires of savers. Their purpose, of course, is to make a profit by purchasing primary securities yielding more than their expenses and the return they must pay on the indirect securities issued. In so doing, they channel funds from the ultimate lender to the ultimate borrower at a lower cost and with less inconvenience than would be possible if the ultimate lender directly purchased primary securities. Financial intermediaries include institutions such as commercials banks, savings banks, and loan associations, life insurance companies, and funds.
1.5.1 CLASSES OF INTERMEDIARIES
There are few classes of intermediaries such as commercial banks, saving and loan association, mutual saving banks, credit unions, life insurance companies, mutual funds, and also pension funds.
1.5.1.1 DEPOSITORY INSTITUTIONS
Commercial banks are by far most important source of funds for business firms in the aggregate. Banks acquire demand and time deposits from individuals, companies, and governments, and, in turn make loans, and investments. Among the loans made to business firms are seasonal and others short-term loans, intermediate-term loans of up to five years, and mortgage loans. Besides performing a banking function, commercial banks affect business firms through their trust departments, which invest in corporate bonds and stocks. They also make mortgage loans available to companies and manage pension funds.
1.6 Commercial Banks
Commercial banks make up the largest group of depository institutions measured by asset size. They perform functions similar to those of savings institutions and credit unions, that is accept deposits and make loans. However, they are still differing in their composition of assets and liabilities, which are much more varied. Commercial banks liabilities usually include several types of no deposit sources of funds, while their loans are broader in range, including consumer, commercial, and real estate loans. One of the commercial banks activity are to regulated separately from the activities of savings institutions and credit unions.
1.7 Saving and Loan Association
Served individuals saver and residential and commercial mortgage borrowers, take the fund of many small savers and then lend this money to home buyers and other type of borrowers.
Have more expertise in analyzing credit, setting up loans, and making collections than individual's savers, so they reduce the costs and increase the availability of real estate loans.
Hold large, diversified portfolios of loans and other assets and thus spread risks in a manner that would be impossible if small savers were making mortgage loans directly.
1.8 Mutual Savings Banks
Operate primarily, accept savings primarily from individuals, and lend mainly on a long-term basis to home buyers and consumers.
1.9 Credit Unions
Cooperative associations whose members are supposed to have a common bond, such as being employees of the same firm.
Member's savings are loaned only to other members, generally for auto purchases, home improvement loans, and home mortgages.
Credit unions are often the cheapest source of funds available to individual borrowers.
2.0 Pension Funds
Retirement plans funded by corporations or government agencies for their workers and administered primarily by the trust departments of commercial banks or by life companies.
2.1 Life Insurance Companies
Take savings in the form of annual premiums, invest these funds in stocks, bonds, real estate, and mortgage and finally make payments to the beneficiaries of the insured parties.
2.2 Mutual Funds
Pool funds and thus reduce the risk by diversification. Different funds are designed to meet the objectives of different types of savers.
2.3 Credit Unions
Credit unions are non profit depository institutions mutually organized and owned by their members (depositors). The primary objective of credit unions is to satisfy the depository and lending needs of their members. Credit unions members deposit are used to provide loans to other members in need of funds. Any earnings from these loans are used to pay higher rates on member deposits, charge lower rates on member loans, or attract new members to other credit unions. Credit unions do not issue common stock, the members are legally the owners of a credit union.
1.5.1.2 CONTRACTUAL SAVING INSTITUTIONS
Savings associations were historically referred to as savings and loans association. Savings banks were established as mutual organizations in which the depositors are also legally the owners of the bank in states that permitted such organizations.
1.5.1.3 INVESTMENT COMPANIES
Investment companies, such as mutual funds and real estate investments trusts (REIT'S), pool the fund of many savers and invest these funds in various types of assets. Mutual funds invest in specific financial assets- such as debt and equity securities of corporations or money market instrument- according to the objectives of the fund. Mutual funds attempt to achieve superior performance through diversification and professional investment management. REITs, as the name suggests, invest their pool of funds in real estate.
