Discuss the primary purpose of financial markets in respect to financial instruments and institutions.
The Primary Purpose Of Financial Markets.
Borrowers and lenders of funds use financial markets for buying necessary goods or for saving. Borrowers (or deficit units) require funds and this is provided by lenders (or surplus units).
Generally deficit units will require large amounts of funding for buying goods such as cars or houses, however most surplus units will not have enough money to lend out to them standalone. Because of this, a financial institution is used to facilitate the flow of funds from the lender to the borrower.
A financial institution such as a bank or credit union will have a large number of small-fund savers at any one time and a small number of large-fund borrowers. Provided that borrowing and saving is spread out over time, there is no problem in providing the surplus units' funds to the deficit units.
Since the primary purpose of financial markets is facilitating the flow of funds (as mentioned above), a financial institution must ensure that there will always be enough money to lend and so must take certain steps to avoid catastrophe.
There must be restrictions on lending according to people's income and assets as well as various other criteria. If this was not the case, the financial institution would not be able to lend funds to deficit units that would be able to pay the loan back.
To ensure that there will always be enough money, people are encouraged to save by providing low interest rates that reward the customer. In the same respect, those that borrow money must pay interest to cover the expenses of the bank's intermediation in borrowing and lending as well as the interest that is paid to the surplus unit.
The bank's intermediation also allows the spread of risk over many borrowers and many lenders.
So far we have seen how financial markets use financial institutions to facilitate the flow of funds, in particular, money. However, as well as money there are other financial instruments that can be traded to facilitate the flow
Borrowers and lenders of funds use financial markets for buying necessary goods or for saving. Borrowers (or deficit units) require funds and this is provided by lenders (or surplus units).
Generally deficit units will require large amounts of funding for buying goods such as cars or houses, however most surplus units will not have enough money to lend out to them standalone. Because of this, a financial institution is used to facilitate the flow of funds from the lender to the borrower.
A financial institution such as a bank or credit union will have a large number of small-fund savers at any one time and a small number of large-fund borrowers. Provided that borrowing and saving is spread out over time, there is no problem in providing the surplus units' funds to the deficit units.
Since the primary purpose of financial markets is facilitating the flow of funds (as mentioned above), a financial institution must ensure that there will always be enough money to lend and so must take certain steps to avoid catastrophe.
There must be restrictions on lending according to people's income and assets as well as various other criteria. If this was not the case, the financial institution would not be able to lend funds to deficit units that would be able to pay the loan back.
To ensure that there will always be enough money, people are encouraged to save by providing low interest rates that reward the customer. In the same respect, those that borrow money must pay interest to cover the expenses of the bank's intermediation in borrowing and lending as well as the interest that is paid to the surplus unit.
The bank's intermediation also allows the spread of risk over many borrowers and many lenders.
So far we have seen how financial markets use financial institutions to facilitate the flow of funds, in particular, money. However, as well as money there are other financial instruments that can be traded to facilitate the flow